Thursday, October 4, 2012

Buy ex-dividend or cum-dividend?

Should an investor buy a stock on the cum-dividend or ex-dividend day?

Will the stock price fall more than or less than the dividend amount on the ex-dividend day?

According to the Federal Reserve Bank of Minnepolis Research Department Staff Report 229, the stock price will fall by an amount less than expected on the ex-dividend day due to the behavior of investors. Under certain conditions, rational investors who have decided to buy would prefer to do so on the ex-dividend day instead of on the cum dividend day. They would rather postpone their trade by a day. Those who have decided to sell, on the other hand, would prefer to advance their sale and do so on the cum-day. Hence, on the ex-day the stock price would rise by a small amount relative to what would otherwise have been expected, ceteris paribus.

This indeed reflect my personal behavior when buying stocks as I would prefer buying on the ex-dividend date. However, we have to take note that there are many other variables and this model of investor behavior does not take into account of the general market sentiment and stock market trend.