A market anomaly is a change in market price of a security that does not result from release of new information in the market. Consistent and recurrent market anomalies signal that the market is not efficient provided that the anomaly is backed by sound economic logic and not just discovered through data mining (and data snooping).
Market anomalies are classified based on the research methods used to discover them: time series anomalies, cross-sectional anomalies, and others such as event studies.
Time series anomalies
Time series anomalies are further classified into calendar anomalies and momentum and overreaction anomalies.
Calendar anomalies include the January effect (turn of the year effect or small firm in January effect), day of the week and weekend effects.
January effect refers to the abnormal returns occurs in (early) January. Possible (partial) explanations include tax-loss selling, which occurs when investors sell loss-making securities in December to reduce their tax bill, and window dressing, when portfolio managers sell risky assets in December to improve their risk/return profile and buy them back after year-end.
Momentum anomalies result from short-term patterns in stock prices. It results from investors’ overreaction because good news tend to inflate stock prices beyond their intrinsic value and bad news tend to depress them. Such an effect causes winners to lose in the long run when the short-term overreaction is reversed and vice versa. The existence of momentum goes against the weak-form efficiency, but some researchers argue that a little bit of serial correlation is expected as prices adjust to new information.
Size effect and value effect are the most common cross-sectional anomalies.
Size effect refers to the observation that small-cap companies outperform large-cap companies on a risk-adjusted basis. Subsequent studies have not confirmed this anomaly either because it was just a chance outcome, and hence not an anomaly, or if it was indeed an anomaly, it has been arbitraged away.
Value effect refers to the consistent superior return earned by value stocks, stocks with low price to earnings and price to book ratios but high dividend yield ratios, as compared to growth stocks.
One explanation for both the size and value effects is that the capital asset pricing model does not capture all risks. Fama and French developed a three-factor model that accounted for size and value factors. Using that model, if the risk is properly accounted for, the value effect vanishes.
Other anomalies included closed-end investment fund discount, earnings surprise, initial public offering and predictability of return based on past information.
Close-end investment fund discount
Closed-end investment fund discount refers to the observation that units of a closed-end mutual fund typically trades at a discount to its net asset value (NAV) per unit. This is an anomaly because theoretically someone can purchase all units, dissolve the fund and be better off. Some researchers argue that the discount is due to fund expenses and expectations about manager performance while others think that it is because the inability of unitholders to sell units back reduces their control on their tax planning. Further, sometimes the difference is attributed to a lack of liquidity and error in NAV calculation. Liquidity and tax planning considerations partially explain the closed-end fund discount phenomenon.
Earnings surprises (earnings different from consensus estimates) are documented to affect stock prices even in the period after the announcement, which shows that markets are not completely semi-strong form efficient. Even though stock prices do adjust to an unanticipated earnings announcement, the adjustment is not complete before and at the time of announcement. This is why companies with positive earnings surprises tend to have superior returns and vice versa. But some researchers discredit such observations as merely an outcome of the research methodology having no economic rationale.
Initial public offerings (IPOs)
Initial public offerings (IPOs) tend to generate abnormal returns immediately after they start trading in the secondary market. It is because investment banks have an incentive to underprice the share issues and because typically there is too much optimism initially which erodes over time. This is also why IPOs typically do not generate a superior return when a relatively long time horizon is considered.