Price anomaly: the price of a dividend-paying stock tends to drift up before the ex-dividend date.
At the aggregate level, this upward drift takes place throughout the entire period from declaration date to ex-dividend date.
Out of 4 possible trading methods to take advantage of this price anomaly, the one that performs best holds the stock throughout the entire period from declaration date to ex-date.
It is possible to hedge and reduce the dispersion of returns by shorting the SPY.
The price of a dividend-paying stock tends to drift up before the ex-dividend date. In this article, I present 4 possible ways to take advantage of this price anomaly, with different holding periods based on different levels of belief in market efficiency.
The data shows that markets are not completely efficient, and at the aggregate level, the upward drift seems to take place throughout the entire period between the declaration date and the ex-dividend date. Thus, the method that performs the best with highest aggregate returns and highest risk-adjusted returns is to buy immediately after dividend declaration and sell right before the ex-dividend date.
In my previous article on dividend stripping, I mentioned a few other price anomalies surrounding dividends. One of them was that the price of a dividend-paying stock tends to drift up before the ex-dividend date. I hypothesized that the upward drift anomaly was due to other people trading other variants of dividend stripping strategies, which was to buy before the ex-dividend date. This article will be an investigation of this price anomaly, whether it is significant across a range of stocks, and which variants of trading methods might be used to take advantage of it.
The period before ex-dividend date
How do we know that a dividend is coming? Well, we find that that a dividend is coming when the dividend is declared. This declaration (or announcement) of a dividend usually takes place at the same time when a company reports its earnings (could be annual earnings or quarterly earnings). This means that there is a limitation in our analysis where we cannot separate the effects of earnings and dividends, but I will talk more about this limitation in the conclusion.
The dividend declaration provides us with the details of the dividend, such as the ex-dividend date (and the record date), the pay-date, and the dividend amount. Since this article is about the time period before the ex-dividend date, the relevant time period for us is between the declaration date and the ex-dividend date. Before the dividend is declared, we do not know exactly when the dividend is coming, and after the ex-dividend date, the price is influenced by other factors (such as the ex-dividend date price drop, and price recovery which is another price anomaly).
This time frame varies widely among stocks. The average MSFT dividend has approximately 2 months between declaration date and ex-dividend date. On the other hand, the average PG dividend has only 1 week between declaration date and ex-dividend date. A special case can be seen in WMT where all the quarterly dividends for the year are all announced at the same time.