Evidence of Size Effect on Stock Returns in India

Abstract

This paper reports the results of a study designed to examine if any firm-specific characteristics explain the cross-sectional variation in stock returns using Fama and Macbeth's methodology. It was found that size (measured by market capitalization), market leverage, price-to-book value, and earnings-to-price ratio were highly correlated with stock returns. While size and price-to-book-value were negatively correlated with stock returns, earningsto- price ratio and market leverage were found to be positively correlated with stock returns. The study also found a flat relationship between returns and beta. However, variables other than size did not have any incremental explanatory power, once the size effect had been adjusted for. On splitting the sample period into pre-95 and post-95 sub-periods, it was found that the above effects were predominant in the post-95 sub-period compared to the pre-1995 one. In the entire sample period, small firms generated an annualized excess return of 70 per cent over the large firms.