Does Size Matter? The Effects of Bid-Ask Spreads and Market Capitalization on Reit Returns
15 Pages Posted: 13 Feb 2010
Date Written: April 1, 1997
The REIT industry has experienced tremendous growth in the 1990s, with its market capitalization quintupling from $9 billion to $58 billion. Over the same time period, REIT liquidity as measured by the percentage bid-ask spread declined significantly from 5.6% to 3.9% (Bhasin, Cole, and Kiely 1996). Because more liquid assets pose less risk to investors, this increased liquidity should come only at the expense of lower expected returns. In this article, we formally test this hypothesis using a model of expected returns developed by Amihud and Mendelson (1989). In their model, the expected return on an asset is an increasing function of systematic risk, residual risk, and market capitalization, and a decreasing function of the percentage bid-ask spread. Because this model of expected return incorporates market capitalization, it also enables us to address the issue of REIT size. Respected institutional players argue that REITs must continue to grow in size in order to be competitive in the marketplace. According to these players, larger REITs can borrow at a lower cost of capital than their smaller counterparts, and Wall Street bids up the share price of such firms. If this argument is true, then size as measured by market capitalization must be priced. Our findings provide do, indeed, provide support for this size argument, but do not support the hypothesized trade-off between liquidity and expected returns.
Keywords: Bid-Ask Spread, Liquidity, Percentage Spread, REIT
JEL Classification: G12, G32
Suggested Citation: Suggested Citation