Do starving investors earn higher returns?
Like the price of food staples, which reach for the skies during the holy month of Ramazan, the stock markets in several Muslim-majority countries report significantly higher returns during Ramazan, thus enabling believers to count their blessings in Dollars, Dinars and Rupees.
Recent research revealed that “stock returns during Ramazan are significantly higher and less volatile than during the rest of the year.” The authors studied stock market returns in 14 Muslim-majority countries (including Pakistan) during 1989 and 2007 and found that the mean annualised return during Ramazan was significantly higher (38 per cent) than the mean return during the rest of the year (4.3 per cent). They also discovered that stock markets were less volatile during Ramazan. The authors called the phenomenon the ‘Ramazan Effect’.
These findings should be of interest to academics studying behavioural finance and institutional investors who are searching for ways to earn higher returns. These findings also challenge one of the fundamental tenants of finance, the efficient market hypothesis, which posits that it is impossible to earn higher returns than the equilibrium returns in the stock market. Put simply, the market cannot be beaten. However, the Ramazan Effect suggests that investors in the 14 Muslim-majority countries may enter the market at the start of Ramazan and hold on to the securities until only the end of the month to make higher than expected returns.
Research in finance documents several ‘violations’ of the efficient market hypothesis. For instance, Michael Dowling and Brian Lucey have found that stock returns in Ireland were correlated with weather patterns, changes in biorhythms (sleep patterns) due to daytime savings, and religious beliefs. Similarly, Frieder and Subrahmanyam discovered that stock returns were correlated with Jewish High Holidays in the US equity markets. For instance, the trading volumes on Rosh Hashanah (a festive day also known as the Jewish New Year) were down, but the equity market returns were positive “again to an extent eight times greater than the average return for the entire sample.” On the other hand, Yom Kippur, which is a day of atonement in the Jewish calendar, both the trade volume and stock prices declined.
The investors’ mood or the state of mind is assumed to have an impact on the way they act or behave. While being elated, investors are less critical and hence are willing to take risks. On the other hand, if the investors are overcome by grief or gloom, they are more likely to suspect all news and trends and may decide to either stay out of the market or be bearish.
In the United States, other departures from efficient markets have also been reported. The January Effect, for instance, accounts for higher than usual rise in stock prices observed from December to January. Similarly, stock prices are often found to be lower on Mondays than otherwise.
The Ramazan Effect was observed for all except Saudi Arabia in the study. Higher Effect was observed for markets in Turkey, Oman, Kuwait and Pakistan. Other research in the past also failed to notice any significant difference in returns during Ramazan in Saudi Arabia. However, the researchers indeed find a significant decline in volatility during Ramazan in the Saudi stock market.
Given that Saudi Arabia is the only Muslim majority country in the sample that uses the Muslim (Hijra) calendar (the rest use Gregorian calendar), the lack of support for Ramazan Effect raise several questions about why such an Effect takes place. The academic literature suggests that since Muslims fast from dawn to dusk during Ramazan and abstain from other physical comforts, the resulting physiological changes accompanied by the desire to atone and be charitable put investors in a state of mind that promotes optimism. If this were to be true, why one does not see higher returns in Saudi Arabia, which happens to be the birthplace of Islam.
Even in countries where higher returns have been reported during Ramadan, published research offers conjecture rather than tangible evidence to explain the Ramazan Effect. After all, firms do not necessarily report higher than usual earnings during Ramadan that may explain the discrepancy in the stock market returns. Instead, the manufacturing, construction, and agriculture output often declines during Ramazan in several Muslim-majority countries. Could it be that religiosity and/or spirituality is indeed behind the higher stock market returns during Ramazan and somehow Saudi Arabia is an exception to the rule.
I have a competing explanation for the higher than usual stock returns during Ramazan in Muslim-majority countries. I base my explanation on the fact that most of these countries have large services sector, which employ millions of workers, but it is still not part of the formal economy. I would argue that the informal sectors come to life during Ramazan and generate sufficient economic output to jolt the entire national economy. The start of Ramazan is akin to Black Friday in the last week of November in the United States that marks the beginning of Christmas shopping season.
The long queues outside of tailoring shops, the post mid-night shopping for gifts in preparation of the Muslim festival of Eid at the end of Ramazan, the significantly higher spending on food during the holy month, and the intercity travel at the end of Ramazan, which puts hundreds of millions on the move, and several similar activities produce considerable and intense economic activity capable of generating higher than usual returns in the stock market.
Let me offer some evidence in support of my abovementioned theory. In the following graph I present the result of Google Searches conducted for the word ‘gift’ (blue line) in Pakistan. The search volume has been normalised to fall between 0 and 100. Also marked on the graph are Christmas/New Year, Valentine’s Day, and Ramazan (in green). Notice that the search for ‘gift’ peaks in Pakistan around Christmas, Valentine’s Day, and Ramazan. Also notice the increase in searches for the word ‘gift’ at the beginning of Ramazan and continuing throughout the holy month suggesting that there is a more sustained focus on gift buying that lasts the entire month rather than peaking for a day or a week. The multiplier effect of the intense activity in the retail and services sectors during Ramazan would be felt in other sectors (e.g., manufacturing, banking, etc.) thus, lifting the stock markets as a consequence.
I can try to explain the lack of Ramazan Effect in Saudi Arabia with the same theory. Given that Saudi economy is driven by petro-chemicals, its stock market (Tadawul) is also weighted heavily by economic sectors that support the oil and gas industry, which relies heavily on immigrant workers from South Asia. During Ramazan many immigrant workers would return to their homelands to celebrate Eid with their families. This may contribute to a decline in industrial production and commerce in Saudi Arabia during Ramazan. The following graph in fact shows a decline in Saudi oil production (millions of barrels per day) around Ramazan/Eid during 2008 and 2011.
It could be religiosity or self interest driving the higher than usual stock market returns in Muslim countries. Regardless of what causes the higher returns, Muslims do have more blessings to count during Ramazan than otherwise.
Dowling, Michael & Lucey, Brian M., 2005. “Weather, biorhythms, beliefs and stock returns — Some preliminary Irish evidence,” International Review of Financial Analysis, Elsevier, vol. 14(3), pages 337-355.
Fazal J. Seyyed, Abraham Abraham, Mohsen Al-Hajji, Seasonality in stock returns and volatility: The Ramadan effect, Research in International Business and Finance, Volume 19, Issue 3, September 2005, Pages 374-383.
Frieder, Laura & Subrahmanyam, Avanidhar, 2001. “Non-Secular Regularities in Stock Returns: The Impact of the High Holy Days on the U.S. Equity Market, Forthcoming in the Financial Analysts Journal,” University of California at Los Angeles, Anderson Graduate School of Management, Anderson Graduate School of Management, UCLA.
Heitham Al-Hajieh, Keith Redhead, Timothy Rodgers, Investor sentiment and calendar anomaly effects: A case study of the impact of Ramadan on Islamic Middle Eastern markets, Research in International Business and Finance, Volume 25, Issue 3, September 2011, Pages 345-356.
Jędrzej Białkowski, Ahmad Etebari, Tomasz Piotr Wisniewski (2012). Fast profits: Investor sentiment and stock returns during Ramadan, Journal of Banking & Finance, Volume 36, Issue 3, March 2012, Pages 835-845, ISSN 0378-4266.
Murtaza Haider, Ph.D. is the Associate Dean of research and graduate programs at the Ted Rogers School of Management at Ryerson University in Toronto. He can be reached by email at email@example.com
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