A Literature Review of the Size Effect

25 Pages Posted: 17 Nov 2010 Last revised: 31 Oct 2011

Date Written: 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.

Keywords: Size effect, size premium, January effect, risk factors, returns

JEL Classification: G12, G14

Suggested Citation

Crain, Michael A., A Literature Review of the Size Effect (October 29, 2011). Available at SSRN: https://ssrn.com/abstract=1710076 or http://dx.doi.org/10.2139/ssrn.1710076

Michael A. Crain (Contact Author)

Florida Atlantic University ( email )

Boca Raton, FL
United States