New paper finds scant evidence of a size effect

BVWireIssue #194-2
November 14, 2018

cost of capital
cost of capital, private company valuation, risk analysis, cost of equity

“The bottom line is that after addressing the facts and fictions of the size effect, we find neither strong empirical evidence nor robust theoretical support for a prominent size premium.” That’s the conclusion of a new paper by Ron Alquist and Ronen Israel (both with AQR Capital Management LLC) and Tobias J. Moskowitz (Yale University). The size effect is the phenomenon that “small” stocks (i.e., those with lower market capitalizations) on average outperform “large” stocks (i.e., those with higher market caps) over time, on average. Some of the facts and fictions they examine are:

  • Fact: The size effect has disappeared or weakened since its discovery;
  • Fiction: The size effect is robust to how you measure size;
  • Fact: The size effect mostly comes from microcap stocks;
  • Fiction: The size effect is likely more than just a liquidity effect; and
  • Fact: The size effect receives disproportionately more attention than other factors with similar or much stronger evidence.

Although this paper backs up other academic research, there is still confusion and debate about the size effect, the authors say. “We examine many claims about the size effect and aim to clarify some of the misunderstanding surrounding it by performing simple tests using publicly available data.”

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