A November Effect? Revisiting the Tax-Loss-Selling Hypothesis

We document the existence of another seasonality in stock returns: A November effect. The uniqueness of this study is that the November effect is observed only after the passage of the Tax Reform Act of 1986. The impact of the Act resides in the treatment and distribution of capital gains and losses by mutual funds. We document a unique and significant relationship between excess returns and the potential for tax-loss-selling and conclude that the November effect is explained by the tax-loss-selling hypothesis. We also show that the January effect in the post-Act period is stronger than in the pre-Act period. This result is likely to be due to the elimination, by the Act, of the preferential treatment for capital gains. The robustness of these conclusions is supported by an analysis of trading volume. The evidence presented in this paper suggests that tax-loss-selling is a dominant explanation for the seasonality of stock returns.