To determine if investors exploit these anomalies and help bring stock prices closer to efficient levels, Calluzzo, Moneta and Topaloglu constructed portfolios from them that were long stocks with positive expected returns and short stocks with negative expected returns. The study covered the period January 1982 through June 2014. Following is a summary of their findings:
- For both the annual and quarterly versions of the anomalies, trading with them was profitable during the original in-sample period. The alpha of the portfolio equally weighted across each of the anomalies was 1.54% per quarter.
- Raw returns in the period after publication decay to an average of 1.05%, a 32% relative reduction. Using the Fama-French three-factor model, there is a reduction in nine of the 14 anomalies.
- During the in-sample, prior-to-publication period, institutional investors did not take advantage of stock return anomalies.
- In the post-publication period, institutions trade to exploit the anomalies. The net change in aggregate holdings (the change in the long leg minus the change in the short leg) is positive.
- Partitioning institutional investors into hedge funds, mutual funds and others, the results are strongest among hedge funds, and then among actively managed mutual funds with high turnover.
- There is a significant negative relationship between institutional trading and future anomaly returns in the ex-post portfolio. Institutional trading after anomaly publication is related to the post-publication decay in anomaly returns.
- There is a significant increase in trading by hedge funds in the period just before publication, suggesting that hedge funds have knowledge about the anomalies prior to journal publication (likely through presentations at conferences or from postings on the Social Science Research Network).
The authors concluded: “Institutional trading and anomaly publication are integral to the arbitrage process, which helps bring prices to a more efficient level.” Their findings demonstrate the important role that both academic research and hedge funds (in their role of arbitrageurs) play in making markets more efficient.