War, Crisis, and the Capital Market: The Anomaly of the Size Effect in Germany, 1872-1990

Abstract

The size effect is an important capital market anomaly, which could not be explained by standard theory so far: stocks of smaller firms do often better than large caps. Risk measures did not invalidate these results in previous studies. Our hypothesis is that the size effect appears (and will re-appear) during the wars and the decade after wars as well as other economic and political crises, because risk-averse investors might tend to buy blue chips. In order to test this, we estimate the size effect for the pre-WWI period (1872-1913) and the WWI period and its aftermath. We connect those time series with Stehle's (1997) estimates for 1954 through 1990, so that a number of hypotheses can be tested with N=78.

Keywords: Size effect, asset pricing, capital market, financial history

JEL Classification: G10, G12, N10, N20, O16