Growth in Average Firm Size of U.S. Industrial Portfolios and the Cross-Section of Expected Returns

Abstract

This paper shows that growth in average firm size in U.S. industrial portfolios predicts future growth in average firm size. Moreover, the payoffs of industrial portfolios sorted by growth in average firm size in the previous period increase linearly as we move from lowest to highest growth in average firm size. The spread between highest and lowest growth in average firm size is economically large and cannot be explained by exposures to standard risk factors or the asset growth effect (Cooper, Gulen, and Schill, 2008). Principal component analysis reveals that this growth in average firm size effect is linked to the first principal component. Moreover, stochastic discount factor model analysis shows that the spread is marginal useful for pricing the cross section of U.S. industrial portfolios.

Keywords: asset pricing, industry portfolios, growth in average firm size, risk factor

JEL Classification: G12, G14