Abstract
Summary The size premium, defined as the return differential between shares of small and large companies, is subject to cyclical fluctuations. This study examines the predictability of this premium for the Swiss stock market applying a new and flexible forecasting approach. Our strategies provide promising information ratios. The results show that risk variables (VIX, TED spread, etc.), the performance of the S&P 500 and statistical variables such as AR(1) terms or trends prove to be successful forecasting variables in our algorithm. Furthermore, variables that sum up the consensus estimates of equity analysts (IBES) make valuable forecast contributions.
Highlights
The size effect is defined as the empirical observation that the equities of small companies –measured in terms of market capitalisation – generate average returns that are systematically higher than those of the CAPM benchmark. Banz (1981) was the first to point out this phenomenon
The size premium – in this study defined as the outperformance of the equities of medium-sized companies over those of large firms – is subject to sharp cyclical fluctuations over time
This empirical observation holds true for Switzerland
Summary
The size effect is defined as the empirical observation that the equities of small companies –measured in terms of market capitalisation – generate average returns that are systematically higher than those of the CAPM benchmark. Banz (1981) was the first to point out this phenomenon. The size effect is defined as the empirical observation that the equities of small companies –measured in terms of market capitalisation – generate average returns that are systematically higher than those of the CAPM benchmark. The theoretical literature proposes at last three different theories explaining the longer-term excess returns of, on the one hand, small-cap companies and, on the other, value stocks.. Company-specific variables can be taken as proxies for risk factors. From this standpoint, the higher returns should considered compensation for higher risks. Companies with the same characteristics should, against this background, show the same sensitivity to various macro-economic factors.. Company-specific factors can pinpoint mispricing by the market.. Different classes of companies profit to different degrees from unanticipated technological innovations. We can repeatedly identify periods in which premiums deviate from their usual patterns.
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