A Literature Review of the Size Effect
Michael A. Crain
Florida Atlantic University; University of Manchester - Manchester Business School; The Financial Valuation Group
October 29, 2011
The size effect in finance literature refers to the observation that smaller firms have higher returns than larger firms, on average over long horizons. It also describes the contribution that firm size has in explaining stock returns. Discovered by Banz (1981) in testing the Sharpe-Lintner Capital Asset Pricing Model, subsequent research finds the size effect has diminished or disappeared since the 1980s in the U.S., UK, and elsewhere following Banz's announcement and launches of small-cap funds. Firm size is thought to proxy for underlying risk factors associated with smaller firms. Observed variations in the size effect can be explained by such underlying factors like market liquidity that change over time. Related research finds the size effect is seasonal. It occurs primarily during January in the U.S. and has had little or no presence in the other 11 months, which confounds empirical research on risk-reward relationships. Research also finds the size effect is concentrated in smaller listed firms, making the effect nonlinear.
Number of Pages in PDF File: 25
Keywords: Size effect, size premium, January effect, risk factors, returns
JEL Classification: G12, G14
Date posted: November 17, 2010 ; Last revised: October 31, 2011
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