Throughout the year, most equities are closely tracking the S&P 500. Every December, however, most equities “split off” from the S&P 500 dependency. This feature of the equities markets enables investors to better diversify their risk in the last month of the year, and also allows room for investing strategies that would be too risky in other months. In short, December is the gamblersâ€™ paradise!
Specifically, the dependency under the consideration is a stock’s beta, a measure of how closely the changes in the price of each stock move in tandem with the changes in the S&P 500. For most stocks during most other months of the year, the beta is different from 0 with 99.99% statistical confidence. In December, however, the statistical significance evaporates, implying that the beta becomes statistically indistinguishable from 0 as stocks mysteriously lose their relationship with the S&P 500.
The cause of this phenomenon is unknown. It may be due to the fact that most firms’ fiscal years coincide with the calendar years, and it is their individual end-of-year performance figures that dominate returns in December. In the remainder of the year, stocks are priced relative to market-wide conditions.
Irene Aldridge is a quantitative portfolio manager at ABLE Alpha Trading, LTD., where she supervises creation and production of quantitative and high-frequency trading strategies. Aldridge is the author of High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems (Wiley, 2009). Her latest research on high-frequency trading is forthcoming in Equity Valuation and Portfolio Management (Frank Fabozzi and Harry Markowitz, eds., Wiley 2011). She can be reached at firstname.lastname@example.org