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Do the stocks of small firms consistently outperform those of larger companies? If so, why, and can investors/traders exploit this tendency? Here is a listing of past blog entries related to to the size effect:
The Behavioral Asset Pricing Model ...investors on the whole base their (mis)perceptions of risk and return on feelings rather than rational pricing analysis. Contrarians may be able to exploit the underpricing of "despised" stocks by focusing on small value.
Fama and French Dissect Anomalies ...some anomalies are stronger and more consistent than others. Momentum appears to be the strongest and most consistent.
Australian Stock Market Anomalies ...the Australian stock market offers several historical anomalies, most notably size and negative earnings-to-price, that investors/traders may be able to exploit.
Does a Weak Dollar Favor Large Capitalization Stocks? ...evidence based on the dollar-euro exchange rate does not reliably support the belief that large capitalization stocks outperform when the dollar is weak or weakening.
Testing the Value Premium Down Under ...there is a highly significant value premium among Australian stocks, and the book-to-market ratio is the best way to capture that premium. A size effect exists only among the very smallest stocks.
The Size Effect in Up and Down Markets ...a small-stock buy-and-hold approach benefits fully from upside volatility but does not suffer the entire penalty of downside volatility.
Quantifying and Exploiting Long (Bull and Bear) Trends ...portfolio management based on statistically reliable characterization of the long-term trend of the stock market offers an economically significant advantage over approaches that ignore the long-term trend.
A Contrarian Play on Small Profitability Laggers? ...small capitalization stocks with low past profitability may be key to exploiting the size effect.
Emergent Size-Value Patterns of Noise? ...the value premium and the size effect are real manifestations of emergent patterns of noise across large groups of stocks.
International Diversification with Small Stocks: A Two-fold Size Effect ...small-capitalization stock funds from other countries offer optimal diversification benefits for investors holding broad U.S. stock market indexes.
Buying and Selling Noise? ...small capitalization value investing works by systematically buying negative noise and selling positive noise.
Dynamics of Size and Value Investing ...as a corollary to mean reversion of firm profitability, asymmetries in small-big and value-growth stock migrations drive the size effect and the value premium.
A Short-term VIX Trading Strategy That Works? ...VIX signals are useful for short-term switching between small-capitalization and large-capitalization stock indexes, especially when VIX is historically high.
Separating Cash Flow and Discount Rate Contributions to Returns ...separating stock returns into those driven by changes in cash flow and those driven by changes in the discount rate helps explain the size effect and the value premium.
Global Pricing of Large-capitalization Stocks? ...investors in large capitalization stocks are likely accepting a worldwide equity premium. Local (and identifiable) pockets of reward-for-risk involve small capitalization stocks.
The Frailty of the Size Premium? ...the empirical evidence for the size effect is superficially consistent, but frail at closer inspection. The size effect is not "dead," but it is ailing.
Abnormal Returns from Small Stocks with Good Prospects ...hidden gems (unlike hidden lumps of coal) generally do not want to be hidden. The best small firms solicit analyst coverage to get investor attention.
The Decline of Stock Picking? ...investors everywhere have increasingly embraced modern portfolio theory, emphasizing risk management (diversification) over stock picking. The best opportunities for (diligent) stock pickers are the stocks of young, small, obscure, foreign firms.
January Effect Alive and Well? ...history still favors small-capitalization value stocks in January.
Technically, It Pays to Think Small ...a trading strategy based on simple moving averages is most appropriate for small capitalization stocks.
Triumph of the Optimists: Chapter-by-Chapter Review (Chapter 9) The size effect is a feature of most world markets. During 1926-2000 in the U.S., nominal annualized returns on large, small and micro capitalization stocks were 10.6%, 11.9% and 12.1%. Soon after its discovery in 1981, the size effect reversed for the balance of the century in most countries, with smaller stocks underperforming large ones. However, the size effect still holds over the very long term. The size effect in the U.S. is wholly attributable to excess returns in January.
See also Blog Synthesis: The Value Premium, since the value premium seems to be intertwined with the size effect.
In summary, recent research indicates that the size effect probably has validity, with results on average concentrated in January.
Establishing and maintaining a portfolio of small-capitalization stocks entails significant transaction fees, and a greater-than-average liquidity burden via the bid-ask spread and the price impact of trading.
