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The Smallest Firm Effect: an International Study

  • De Moor, Lieven

    ()

    (Hogeschool-Universiteit Brussel (HUB), Belgium)

  • Sercu, Piet

    ()

    (K.U. Leuven, Faculty of Business and Economics, Research Center of International Finance and Louvain School of Management, Department of Finance)

Using a carefully screened and ltered international data base with a wide coverage across countries and size classes, this paper identies and documents a post-1980s size effect which is persistent, not picked up by a Fama-French-style SMB, and largely due to the smallest-decile stocks. We test for potential explanations (such as market risk, infrequent trading, nancial distress risk, missing book-values, momentum, liquidity risk, changing business conditions, January effect, exchange risk, time-varying risk loadings and dividend yield effects), but none can quite explain the international size effect, whether separately or jointly. Fully identifying the missing risk factor is beyond the scope of this paper but we do nd that dividend yield shows up as a signicant characteristic in the cross-section of risk-adjusted returns, even after controlling for time-varying risk loadings linearly related to dividend yield. When we construct two ad-hoc risk factors that jointly capture the documented size effect, and then correlate these factors with characteristics-based portfolios, we likewise find that especially dividend yield seems to play an important role in the missing risk factor. More generally, this paper revives the debate on the small-rm effect and, we hope, will stimulate further research on a class of stocks that are too interesting to ignore.

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Paper provided by Hogeschool-Universiteit Brussel, Faculteit Economie en Management in its series Working Papers with number 2011/18.

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Length: 82 page
Date of creation: Sep 2011
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Handle: RePEc:hub:wpecon:201118
Contact details of provider: Web page: http://research.hubrussel.be

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