The day-of-the-week effect as a risk for hedge fund managers / André Heymans

The day-of-the-week effect is a market anomaly that manifests as the cyclicalbehaviour of traders in the market. This market anomaly was first observed by M.F.M.Osborne (1959). The literature distinguishes between two types of cyclical effects inthe market: the cyclical pattern of mean returns and the cyclical pattern of volatility inreturns.This dissertation studies and reports on cyclical patterns in the South African market,seeking evidence of the existence of the day-of-the-week effect. In addition, thedissertation aims to investigate the implications of such an effect on hedge fundmanagers in South Africa.The phenomenon of cyclical volatility and mean returns patterns (day-of-the-weekeffect) in the South African All-share index returns are investigated by making use offour generalised heteroskedastic conditional autoregressive (GARCH) models. Thesewere based on Nelson's (1991) Exponential GARCH (EGARCH) models. In order toaccount for the risk taken by investors in the market Engle et al's, (1987) 'in-Mean'(risk factor) effects were also incorporated into the model. To avoid the dummyvariable trap, two different approaches were tested for viability in testing for the day-of-the-week effect. In the first approach, one day is omitted from the equation so as toavoid multi-colinearity in the model. The second approach allows for the restriction ofthe daily dummy variables where all the parameters of the daily dummy variables addsup to zero.This dissertation found evidence of a mean returns effect and a volatility effect (day-of-the-week effect) in South Africa's All-share index returns data (where Wednesdayshave been omitted from the GARCH equations). This holds significant implications forhedge fund managers. as hedge funds are very sensitive to volatility patterns in themarket, because of their leveraged trading activities. As a result of adverse pricemovements, hedge fund managers employ strict risk management processes andconstantly rebalance their portfolios according to a mandate, to avoid incurring losses.This rebalancing typically involves the simultaneous opening of new positions andclosing out of existing positions. Hedge fund managers run the risk of incurring lossesshould they rebalance their portfolios on days on which the volatility in market returnsis high. This study proves the existence of the day-of-the-week effect in the SouthAfrican market.These results are further confirmed by the evidence of the trading volumes of the JSE'sAll-share index data for the period of the study. The mean returns effect (high meanreturns) and low volatility found on Thursdays, coincide with the evidence that tradingvolumes on the JSE on Thursdays are the highest of all the days of the week. Thevolatility effect on Fridays, (high volatility in returns) is similarly correlated with theevidence of the trading volumes found in the JSE's All-share index data for the periodof the study. Accordingly. hedge fund managers would be advised to avoid rebalancingtheir portfolios on Fridays, which show evidence of high volatility patterns. Hedge fundmanagers are advised to rather rebalance their portfolios on Thursdays, which showevidence of high mean returns patterns, low volatility patterns and high liquidity.