Do Beta Pricing Models Explain January Mean Reversion in Stock Returns?

Jegadeesh (1991) finds evidence of January mean reversion in stock returns. In this paper we attempt to distinguish between two competing economic explanations of January mean reversion in returns: (1) mispricing in irrational markets versus (2) predictable time variation in security risk premia. Excess portfolio returns are decomposed into "explained" and "unexplained" components using the Fama-French (1993) pricing model. The explained excess returns exhibit January mean reversion. The unexplained excess returns are not mean reverting. Mean reversion is therefore consistent with rational pricing in the framework of the Fama-French model. Mean reversion can be attributed to the component of return related to a relative distress factor (SMB). A comparison with the Chen, Roll, and Ross (1986) macroeconomic factors reveals that mean reversion is due to the components related to SMB and bond default premium. Copyright 1999 by MIT Press.