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| The weekend effect |
| Mukul Pal / May 05, 2011, 00:13 IST |
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The idea of patterns and order is used conveniently by behavioural finance to challenge conventional economics. But the question of why that order exists has not been researched.
Last time, we mentioned how behavioural finance used the idea of mean reversion to prove that classical economics idea of order and randomness were inconsistent. The new subject went all the way to prove this inconsistency and illustrate that extreme losers outperformed the extreme winners consistently.
During my lecture on behavioural finance at the Babes Bolyai University in Cluj (named after János Bolyai, the famous Hungarian mathematician who established non-Euclidean geometry in 1860, and Victor Babes, one of the early bacteriologists), I was questioned if patterns worked, then one should focus on finding that pattern.
The question was genuine, but behavioural finance does not give an answer to this. On one side, it uses the idea of seasonality to challenge economics, while on the other side, it does not give a pattern solution. The subject somehow avoids the idea of seasonality totally, preferring to concentrate on explaining human follies than on other working patterns in markets. Is this not an inconsistency in behavioral finance?
I was discussing this gap in behavioral finance research with Dr Nistor, with whom I had authored the idea of performance cyclicality and showcased seasonality among BRIC (Brazil, Russia, India and China) countries’ performance in 2007. We were wondering was the idea of seasonality and time tough to deal with? When inter-temporal choices clearly presented itself to behavioural finance experts, why did not they talk about the idea of ‘time’ more? Was it a tougher road to take talking about patterns when the subject had a charted path to illustrate error-prone human decision making? Well, we don’t know why behavioural finance research credits cyclicality as an existing phenomenon but does not go further?
In 1931, M J Fields from Harvard wrote a paper on weekend effect in the journal of business. The paper was investigating the conventional Wall Street wisdom at the time that “the unwillingness of traders to carry their holdings over the uncertainties of a weekend leads to the liquidation of the long accounts and a consequent decline of security prices on Saturday”. He found prices not only rose on Saturdays but also were on average 52 per cent time more than the Friday to Monday average for the 717 weekends he had studied.
Till 1945, Saturday used to be a trading day. Fields’ idea was revisited by Frank Cross in 1973, who found that in S&P500, there were 60 per cent positive Fridays, but only 40 per cent positive Mondays. Cross said, “The probability that such a large difference would occur by chance is less than one in million”. This is known as the weekend effect, which talks about strange order. This order is thoroughly used to challenge randomness in classical economics, but the question why this order in time works is unanswered by behavioural finance.
The author is CMT, and Co-Founder, Orpheus CAPITALS, a global alternative research firm
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