Abstract
Recent studies on the New York Stock Exchange have provided empirical evidence which suggests that small market capitalization firms outperform large market capitalization firms in terms of share price performance. This appears valid even after adjusting for the additional risk borne by the small firms. This has become known as the 'small firm effect' and questions the validity of many traditional pricing models such as the Capital Asset Pricing Model. In this paper, the small firm effect is examined on the Johannesburg Stock Exchange. The risk-adjusted performance of portfolios comprising large firms is contrasted with that of small firms. Three measures of size are used, namely market capitalization, asset base and traded volume. In all three cases, no evidence of a small firm effect is apparent. Indeed, if anything, the large firms appear to provide superior investment performance on the JSE.
Highlights
One of the major developments in capital market research during the past quarter of a century has been the emergence of a number of asset pricing theories
Several studies querying the general validity of the Capital Asset Pricing Model (CAPM) have appeared and numerous authors have suggested that there are systematic factors other than the covariance between the asset's return and the market return that are relevant to asset pricing
An initial examination of the small firm effect on the JSE was performed by including only shares ranked small on all three size criteria in the 'small share' portfolio
Summary
One of the major developments in capital market research during the past quarter of a century has been the emergence of a number of asset pricing theories. The most famous and widely applied of these theories has been the Capital Asset Pricing Model (CAPM). This theory postulates that the return that can be expected from an asset is a linear function of its covariance with the market. As a consequence the theory implies that only the covariability of the asset with the market of all possible assets is relevant for portfolio decisions The small firm effect basically states that smaller firms (in terms of market capitalization) tend to earn higher returns than would be expected under the CAPM. The conclusion is that in deriving an asset pricing model the siz.e of the asset (in financial terms) should be taken into account as well as the covariability of the asset return with the market return
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