Can the Changes in Fundamentals Explain the Attenuation of Anomalies?

TY - JOUR

T1 - Can the Changes in Fundamentals Explain the Attenuation of Anomalies?

AU - Choy, Siu Kai

AU - Lewis, Craig

AU - Tan, Yongxian

N1 - Publisher Copyright: © 2023 Elsevier B.V.

PY - 2023/8

Y1 - 2023/8

N2 - The existing literature attributes the recent decay of stock market anomalies to increased arbitrage activities (e.g., Chordia, Subrahmanyam, and Tong, 2014; McLean and Pontiff, 2016; Green, Hand, and Zhang, 2017). In this paper, we present evidence that the apparent demise of several prominent classes of stock market anomalies is better explained by changes in underlying fundamentals. The attenuation of anomalies in the Momentum, Investment, and Profitability categories are accompanied by a reduced difference in fundamental performance between the long- and short-leg portfolios, as measured by the fundamental return from a two-capital investment CAPM. After accounting for the change in fundamental return, the attenuation of Investment and Profitability anomalies decreases to statistically insignificant levels. These results are consistent with the q-theory of investment, which attributes the attenuation of stock returns and fundamental returns of anomalies to the time variation in discount rates implied by fundamentals. We also show that neither academic publication nor proxies for increased arbitrage activities can explain the attenuation of these anomalies.

AB - The existing literature attributes the recent decay of stock market anomalies to increased arbitrage activities (e.g., Chordia, Subrahmanyam, and Tong, 2014; McLean and Pontiff, 2016; Green, Hand, and Zhang, 2017). In this paper, we present evidence that the apparent demise of several prominent classes of stock market anomalies is better explained by changes in underlying fundamentals. The attenuation of anomalies in the Momentum, Investment, and Profitability categories are accompanied by a reduced difference in fundamental performance between the long- and short-leg portfolios, as measured by the fundamental return from a two-capital investment CAPM. After accounting for the change in fundamental return, the attenuation of Investment and Profitability anomalies decreases to statistically insignificant levels. These results are consistent with the q-theory of investment, which attributes the attenuation of stock returns and fundamental returns of anomalies to the time variation in discount rates implied by fundamentals. We also show that neither academic publication nor proxies for increased arbitrage activities can explain the attenuation of these anomalies.

UR - http://www.scopus.com/inward/record.url?scp=85159803959&partnerID=8YFLogxK

U2 - 10.1016/j.jfineco.2023.04.005

DO - 10.1016/j.jfineco.2023.04.005

M3 - Article

SN - 0304-405X

VL - 149

SP - 142

EP - 160

JO - JOURNAL OF FINANCIAL ECONOMICS

JF - JOURNAL OF FINANCIAL ECONOMICS

IS - 2

ER -