Behavioral Finance

CHAPTER 15

Fama-French and Mean Reversion: Which Is It?

Contrarian investing has a long history in the stock market. The most famous of the contrarians was Benjamin Graham. Together with David Dodd, Graham pioneered what came to be known as value investing, but could just as easily be labeled contrarian investing.1 Contrarian investing means, roughly speaking, buying stocks that other people don't like. How do you know other people don't like these stocks? Because they have low prices. But low prices compared to what? Value investors say that you should buy stocks that have low prices compared to their earnings or compared to their book value. This is essentially the Fama-French thesis. A true contrarian investor goes against the crowd. Look for stocks that are performing poorly, buy those stocks, and avoid stocks that have been strong performers. This view is that of De Bondt-Thaler. Are these the same thing? There are some important similarities in the data.

THE MONTH OF JANUARY

Something interesting appeared, buried in the data analysis in the Fama-French study:

The average January slopes for ln(BE/ME) are about twice those from February to December. Unlike the size effect, however, the strong relation between book-to-market equity and average return is not special to January . . . there is a January seasonal in the book-to-market equity effect, but the positive relationship between BE/ME and average return is strong throughout the year.2

This was not the first sighting of ...