May a tax-loss selling hypothesis explain the size effect? An empirical study of size seasonality from the UK

Abstract

The United Kingdom offers the opportunity to study the tax-loss selling hypothesis in a country where the tax year-end and fiscal laws differ from the United States. In this thesis, we studied the relationship between the potential seasonality of the Size effect and the tax-loss selling hypothesis in this particular country. Furthermore, we covered the period between January 2004 and December 2020, after the Finance Act of 1998 that aimed to reduce tax-loss selling incentives.

In order to investigate our research question, we applied multifactor models and statistical tools to demonstrate whether a Size effect was present in the UK and whether it exhibited seasonal patterns. Moreover, in the light of recent findings, we examined whether quality may revive the Size effect. Finally, we investigated throughout this document whether our findings were consistent with the tax-loss selling hypothesis given the specificities of the United Kingdom.

Our findings indicated that, although a Size effect may have been present in the UK market during the period studied, we did not uncover robust evidence of its seasonality outside the smallest size decile. Indeed, our smallest decile portfolio was the only one that exhibited a seasonal pattern consistent with the tax-loss selling hypothesis in April. Following our study of decile portfolios, we found evidence of a Size effect for our SMB factor throughout the year but no robust evidence of its seasonality. Even when we controlled for quality, as in Asness et al. (2018), we noticed an improvement in the SMB alpha throughout the year and a lack of evidence regarding its seasonality.

Therefore, we could not find sufficient evidence to support a tax-loss selling hypothesis as a rationale behind the overall Size effect, in the UK market, during the period studied, except for a portfolio composed of the tiniest and most illiquid stocks.