Research paper finds the size premium mostly nonexistent

BVWireIssue #207-1
December 4, 2019

cost of capital
cost of capital, discount rate, private company valuation, risk analysis, cost of equity, size effect

“Investors require no premium to hold small stocks over big stocks in normal times,” says a recently updated paper on the size premium. The study finds that the size premium in listed firms is nonlinear, occurring only in very “bad” times (when stock prices are low), which is “less than 30% and possibly less than 15% of the time.” That means the size premium is nonexistent more than 70% of the time. The paper’s author, Thiago de Oliveira Souza (University of Southern Denmark; Danish Finance Institute), argues that asset pricing models should account for the states of economic conditions in addition to firm size. The paper is titled “Aggregate Price of Risk and Tests of the Size Premium” and is the latest in a number of recent academic papers that find that the size premium has largely disappeared since the 1980s when it was first documented by Rolf Banz. The recent papers include “Firm Size and Stock Returns: A Quantitative Survey,” “Why Has the Size Effect Disappeared?” and “The Size Premium and Macro Volatility Risks: Evidence From US and UK Equity Markets.”

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