Evidence on the Behavior of Bid and Ask Prices at the Turn of the Year: Implications for the Survival of Stock Return Seasonality

Abstract We analyze changes at the turn of the year in the relative and standardized bid‐ask spreads of New York Stock Exchange stocks before and after the introduction of personal income taxes in 1917. Previous research indicates the return seasonal arose in 1917. Here, we investigate when spread seasonals arose and whether spread changes are cross‐sectionally correlated with the return seasonal. The results indicate that the year‐end selling pressure, which began in 1917, is apparent as downward shifts in the stocks' bid and ask prices rather than as widening spreads. Additional evidence suggests the January return seasonal originated as compensation to specialists, as well as to competing traders, for incurring the costs of providing liquidity during the tax‐induced seasonal trading pattern.