The Return of the Size Anomaly: Evidence from the German Stock Market

Abstract

This paper examines the size-effect in the German stock market and intends to address several unanswered issues on this widely known anomaly. Unlike recent evidence of a reversal of the size anomaly we document a conditional relation between size and returns. We also detect strong momentum across size portfolios. Our results indicate that the marginal effect of firm size on stock returns is conditional on the firm’s past performance. We use an instrumental variable estimation to address Berk’s critique of a simultaneity bias in prior studies on the small firm effect and to investigate the economic rationale behind firm size as an explanatory variable for the variation in stock returns. The analysis in this paper indicates that firm size captures firm characteristic components in stock returns and that this regularity cannot be explained by differences in systematic risk.

Keywords: Size-effect, capital market anomaly, CAPM, efficient markets, momentum

JEL Classification: G12, G14, C21, C31