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Size Effect

Do the stocks of small firms consistently outperform those of larger companies? If so, why, and can investors/traders exploit this tendency? These blog entries relate to the size effect.

The Behavioral Asset Pricing Model

Do investors price stocks based mostly on rational analysis or feelings? In their February 2008 paper entitled “Affect in a Behavioral Asset Pricing Model”, Meir Statman, Kenneth Fisher and Deniz Anginer use survey results to investigate both the objective and subjective (perceived) connections between risk and return. Using results of: (1) the 1982-2006 annual Fortune surveys of senior executives, directors and security analysts regarding the long-term investment value of companies; and (2) May and July 2007 surveys of high-net worth clients of a large investment firm, they conclude that: Keep Reading

Fama and French Dissect Anomalies

Which stock return anomalies are trustworthy, and which are not? In the June 2007 draft of their paper entitled “Dissecting Anomalies”, Eugene Fama and Kenneth French apply both sorts and regressions to examine the robustness of the momentum, net stock issuance, accruals, profitability and asset growth anomalies. They note that sorts on an anomaly variable offer a simple picture of how average returns vary, but microcaps (a few big stocks) can dominate the performance of a sort-based equal-weighted (value-weighted) hedge portfolio. In addition, sorts are ill-suited to determinations of: (1) the exact relationship between an anomaly variable and returns, and (2) relationships among anomalies. They note also that extreme behavior by microcaps and outliers generally can distort inference from regressions. Using a robust set of firm data for a broad set of U.S. stocks allocated to three size groups (microcap, small and big) over the period 1963-2005, they conclude that: Keep Reading

Jim Cramer’s Gaps and Reversals

Are Jim Cramer’s stock recommendations on CNBC’s Mad Money most meaningful for small-capitalization stocks, for which prices are most susceptible to influence by the concerted behavior of a group of individual investors? In their September 2007 working paper entitled “The Performance and Impact of Stock Picks Mentioned on Mad Money, Bryan Lim and Joao Rosario evaluate the show’s ability to move markets over the short term and to forecast winners and losers over the long term. Using a sample of 10,589 Mad Money buy and sell recommendations representing 2,074 distinct firms, either initiated by Jim Cramer or provided by him in response to callers, from shows aired between June 28, 2005 and December 22, 2006, they conclude that: Keep Reading

Australian Stock Market Anomalies

Are anomalies observed with varying and changing levels of confidence among U.S. stocks, such as the size effect and the value premium, evident among stocks of other countries? In their recent paper entitled “Anomalies and Stock Returns: Australian Evidence”, Philip Gharghori, Ronald Lee and Madhu Veeraraghavan test for the existence among Australian stocks of a size effect, book-to-market effect, earnings-to-price (E/P) effect, cash flow-to-price (C/P) effect, leverage (debt-to-equity) effect and liquidity (share turnover) effect. Using stock price data for 1/92-12/05 and associated accounting data for 1/92-12/04, they conclude that: Keep Reading

The Size Effect in Up and Down Markets

Does the size effect, the tendency of small capitalization stocks to outperform, hold in both advancing and declining markets? In their March 2007 paper entitled “Stock Market Returns and Size Premium”, Jungshik Hur and Vivek Sharma explore how the size premium differs when the overall stock market is moving up and down. Using monthly return data for a sample of NYSE/AMEX stocks for July 1931 through December 2004 and NASDAQ stocks for June 1975 through December 2004, they conclude that: Keep Reading

Quantifying and Exploiting Long (Bull and Bear) Trends

Attempting to follow long stock market trends is a common investment approach, with much guru attention focused on calling long-term tops and bottoms. Is this approach meaningful for investors as an avenue to improve upon buy-and-hold performance? In the December 2006 version of his paper entitled “Analyzing Regime Switching in Stock Returns: An Investment Perspective”, Jun Tu investigates the potential importance to investors of exploiting differences between bull and bear markets within a Bayesian framework that accommodates considerable uncertainty. Using monthly value-weighted stock return and volatility data for July 1963 to February 2006 (512 observations), he finds that: Keep Reading

A Contrarian Play on Small Profitability Laggers?

Why do small capitalization stocks as a group tend to outperform the broad market? Do small firms represent relatively high risk of financial distress (with attendant reward), or are they victims of systematic investor overreaction to past poor performance? In the 2006 update of their paper entitled “Can Overreaction Explain Part of the Size Premium?” Ozgur Demirtas and Burak Güner investigate irregularities in the historical returns of small capitalization stocks to identify the source of the size effect. Using returns and financial data for NYSE/Amex/Nasdaq stocks over the period July 1971 through June 2001, they conclude that: Keep Reading

Emergent Size-Value Patterns of Noise?

Are there investing/trading strategies that can turn stock price noise into alpha? More specifically, are there types of stocks for which the noise has a systematic effect on price? In the October 2006 draft of their paper entitled “Does Noise Create the Size and Value Effects?”, Robert Arnott, Jason Hsu, Jun Liu and Harry Markowitz model the cross-sectional effects of mean-reverting noise on randomly walking stock values. Noise (for example, from overreacting, informationally challenged and/or liquidity-driven investors/traders) introduces random transients of inefficiency. Based on this model, they conclude that: Keep Reading

International Diversification with Small Stocks: A Two-fold Size Effect

Are there diversification and return advantages from getting off the beaten path (to small-capitalization stocks) when diversifying internationally? In their September 2006 paper entitled “International Diversification with Large- and Small-Cap Stocks”, Cheol Eun, Wei Huang and Sandy Lai compare the benefits of using large-capitalization and small-capitalization stocks to diversify across countries. Taking the perspective of a dollar-based investor, they examine diversification across ten countries with open capital markets (Australia, Canada, France, Germany, Hong Kong, Italy, Japan, the Netherlands, the United Kingdom and the United States). Using monthly size and return data for three market capitalization-based funds (large-cap, mid-cap and small-cap) for each country over the period 1980-1999, they conclude that: Keep Reading

Buying and Selling Noise?

If noise is a significant component of stock prices, does a portfolio that favors large market capitalization stocks automatically underperform? In the May 2006 draft of their paper entitled “Pricing Noise, Rejecting the CAPM and the Size and Value Effects”, Robert Arnott and Jason Hsu examine the implications of a very simple model that assumes stock prices deviate from fundamental value based on a single source of unknown risk (noise). They assume the deviations revert to a mean of zero, with no long-term effect on stock returns. Based on this model, they conclude that: Keep Reading

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