### Robustness Tests for Ten Popular Stock Return Anomalies

**March 28, 2011** - Big Ideas, Buybacks-Secondaries, Fundamental Valuation, Momentum Investing, Size Effect, Value Premium

In their March 2011 paper entitled “The Shrinking Space for Anomalies”, George Jiang and Andrew Zhang investigate the robustness of ten well-known anomalies by iteratively “shrinking the stock space” in two ways to determine whether and how the anomalies really work. The ten anomaly variables are: size, book-to-market ratio, momentum, two liquidity measures, idiosyncratic volatility, accrual, capital expenditure, sales growth and net share issuance. The first way of “shrinking the stock space” involves: (1) ranking the universe of stocks by each of the ten anomaly variables into deciles; (2) iteratively trimming deciles from side of a variable distribution that a hedge portfolio would sell and the side that a hedge portfolio would buy; and, (3) retesting the strength of the anomaly associated with the variable after each iterative trimming. The second way of “shrinking the stock space” involves: (1) trimming from the sample stocks with the smallest market capitalizations and the most extreme book-to-market ratios until size, book-to-market and momentum no longer have significant four-factor alphas for value-weighting and equal equal-weighting (thereby “perfecting” the sample for the four-factor model); and, (2) retesting the strength of the anomalies associated with the other seven variables using the perfected sample. This approach obviates weaknesses in alpha measurement via the commonly applied but imperfect three-factor (market, size, book-to-market) and four-factor (plus momentum) risk models. Using firm characteristics and trading data for all non-financial NYSE, AMEX, and NASDAQ common stocks over the period July 1962 through December 2007, *they find that:* Keep Reading