Why does the stock market get Monday blues? It's the weekend effect

The “weekend effect” is a prominent trend noted in stock markets the world over. The weekend effect, sometimes also called the Monday effect, refers to an anomaly where the stock prices are high on Friday and comparatively lower on Monday when the weekend has passed.

We take a look at how prominent the effect is, and some reasons behind it.

The weekend effect- a longstanding anomaly

Research suggests that the effect has existed as far back as 1885.

Originally identified by Gibbons and Hess in 1981, this pattern does not align with the expected behaviours dictated by market efficiency theories.

The efficient market hypothesis states that stock prices are random and that investors cannot make abnormal profits using historical prices.

According to these theories, anomalies like the weekend effect shouldn’t exist, as they imply a regular pattern of price changes that could be predicted and exploited, contradicting the notion of market efficiency.  The weekend effect patterns in return and volatility can allow investors to take advantage of relatively regular market shifts.

Weekend effect in Indian stock market

Specific studies focusing on the Indian stock market, such as those by Roger Ignatius in 1992 and later by Golaka Nath and Manoj Dalvi in 2004, confirmed a mild presence of the weekend effect during their respective study periods. Despite confirming its existence, researchers have struggled to pinpoint a definitive cause for the effect in the Indian context.

Why the market gets Monday blues

Some researchers have attributed part of the weekend effect to the settlement period. The Indian stock market largely follows the T+1 settlement system. This means that it will take one business day to settle a stock purchase related transactions.

If an investor buys shares of Monday, they must pay for said shares by Tuesday. Stocks purchased on Tuesday must be paid for and delivered by Wednesday, and so on. However, since the stock market is closed on Saturdays and Sundays, a transaction made on Friday has to be settled on Monday. This means that investors who buy shares on a Friday gets two extra days to pay for what they bought. This means that buyers could have the shares, and pay for them two days later than they would have otherwise had to.

For people investing or trading in large sums of money, such as institutional investors, these two extra days mean two less days of paying interest (in case they are taking out a loan to buy stocks). They are likely to increase their buying activity of Friday for this reason.

Greater demand for stocks due to their buying preference could push the market higher on Fridays.

Another perspective proposed that the tendency of companies to release unfavourable news on Friday after markets close. This is so that the investors take two days to absorb in the bad news, and the impact on stock prices is a little muted. Then, the reaction to the bad news– in the form of a dip in investor confidence and selling of shares– comes on Monday. This may contribute in pulling the stock market down at the start of the week.

The mystery remains

Various models attempt to explain the fluctuations in stock returns by analysing fundamental factors, such as a company’s financial information. However, there are still some aspects of these fluctuations that cannot be explained by these models. These unexplained fluctuations could be attributed to factors such as trends in fundamental factors, economic cycles, and news events that impact investor sentiment. Despite many studies, the “weekend effect” in stock returns remains a complex phenomenon that is not fully understood by traditional financial theories. This effect is likely influenced by institutional behaviours, news timing, and investor sentiment.

With inputs from agencies