On the Information Uncertainty Risk and the January Effect
I provide a risk-based rational explanation for the seasonal regularity of January in stock returns by suggesting a common risk factor related to the information uncertainty caused by earnings volatility. When the two-factor model with the market risk factor and this common risk factor is used, there is a remarkable improvement in explaining the January effect. With the adjustment of raw returns for risk through this two-factor model, the systematic pattern in the residual returns across firm size disappears. This risk factor also dominates the other risk factors in explaining the cross section of stock returns in January.
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