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Is the Size Premium Really Driven by Firm Size?

Zhiyao Chen, Jun Li and Huijun Wang
The Journal of Investing August 2021, 30 (5) 127-143; DOI: https://doi.org/10.3905/joi.2021.1.180
Zhiyao Chen
is an assistant professor in the Department of Finance at the Chinese University of Hong Kong in Hong Kong
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Jun Li
is an associate professor in the Department of Finance and Managerial Economics at the University of Texas at Dallas in Richardson, TX
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Huijun Wang
is an assistant professor at Auburn University’s Harbert College of Business in Auburn, AL, and the University of Melbourne in Melbourne, Australia
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Abstract

By decomposing firm size into horizon-based components, the authors find that the changes in firm size in prior years, instead of its recent level, drive the size premium. Specifically, size five years ago explains 80% of the current firm size but has little predictive power for the size premium. In contrast, the change in size over the prior two to five years explains only 18% of the size but almost completely captures the size premium. Their decomposition indicates that not all small stocks earn a size premium. Only small stocks that had significant losses in market value in the prior two to five years earn a premium. This analysis also offers new insights into the disappearance of the size premium and the return behaviors of new entrants.

TOPICS: Security analysis and valuation, analysis of individual factors/risk premia, quantitative methods, statistical methods, performance measurement

Key Findings

  • ▪ The authors decompose firm size into horizon-based components and find the size premium is driven by the size change during the prior two to five years. As such, a better strategy for investors who are interested in the size premium is to trade on the prior two- to five-year size change.

  • ▪ Not all small stocks earn a size premium. Only small stocks that had significant losses in market value in the prior two to five years earn a premium.

  • ▪ Although the size premium is documented to have disappeared between the early 1980s and early 2000s, the premium related to the prior two- to five-year size change remains strong during this period.

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The Journal of Investing: 30 (5)
The Journal of Investing
Vol. 30, Issue 5
August 2021
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Is the Size Premium Really Driven by Firm Size?
Zhiyao Chen, Jun Li, Huijun Wang
The Journal of Investing Jul 2021, 30 (5) 127-143; DOI: 10.3905/joi.2021.1.180

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Is the Size Premium Really Driven by Firm Size?
Zhiyao Chen, Jun Li, Huijun Wang
The Journal of Investing Jul 2021, 30 (5) 127-143; DOI: 10.3905/joi.2021.1.180
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  • Article
    • Abstract
    • RELATION TO THE LITERATURE
    • DECOMPOSING FIRM SIZE
    • DECOMPOSING THE SIZE PREMIUM
    • FURTHER IMPLICATIONS
    • CONCLUSION
    • ENDNOTES
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