Discount rates, market frictions and the mystery of the size premium
AbstractI document the empirical evidence showing that the size premium only exists when the median book-to-market ratios in the market is high. I argue that this evidence supports the hypothesis that the size effect is a consequence of market frictions and not a risk factor priced in equilibrium. High discount rates lower stock valuations and increase the overall book-to-market ratios in the market. They are also associated with the low risk bearing capacity, limited risk sharing and high uncertainty that increase market frictions. Ranking the years in book-to-market quantiles, as a proxy for discount rates, reveals that the size premium is usually statistically significant exclusively in the top book-to-market quantile. This evidence is robust to changes in the number of quantiles; in the US in different sub periods, and in the UK; considering both the Fama/French SMB factor or the individual size portfolios; and also controlling for market risk.
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Bibliographic InfoPaper provided by Job Market Papers in its series 2013 Papers with number pde868.
Date of creation: 29 Nov 2013
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Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-12-06 (All new papers)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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"Capital Mobility and Asset Pricing,"
1478, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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- Fama, Eugene F. & French, Kenneth R., 2012. "Size, value, and momentum in international stock returns," Journal of Financial Economics, Elsevier, vol. 105(3), pages 457-472.
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