Abstract
It is agreed among investors as well as academics that a comparison of alternative investments should be based on risk-adjusted returns. Although a debate exists regarding the validity of the capital asset pricing model (CAPM), the most common risk measure by which returns are adjusted is the CAPM beta. Very little attention, however, is given to the holding period returns by which beta is calculated. Beta is usually calculated with either weekly or monthly returns, whereas the typical planned investment horizon is a year or more. Levy and Levy show that a systematic bias in the risk-adjusted return ranking occurs when there is such a mismatch between the planned investment horizon and the holding period employed to calculate beta. Their results are of particular importance in measuring the small firm effect; that is, although with monthly returns a large small-firm effect prevails, a substantial portion of this effect is a financial mirage and disappears with annual returns. The authors’ findings have important implications for managers as well as investors in small-cap funds. <b>TOPICS:</b>Volatility measures, financial crises and financial market history, exchanges/markets/clearinghouses
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