April 2014
Intermediate to advanced
1344 pages
44h 24m
English
book
Cost of Capital: Applications and Examples, + Website, 5th Edition
by Shannon P. Pratt, Roger J. Grabowski, Richard Brealey
Content preview from Cost of Capital: Applications and Examples, + Website, 5th Edition
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CHAPTER 14
Size Effect1
James Harrington
Size as a Predictor of Equity Returns
Possible Explanations for the Greater Returns of Smaller Companies
The Size Effect over Longer Time Periods
The Size Effect Tends to Stabilize over Time
The Size Effect: Empirical Evidence from Morningstar and Duff & Phelps Studies
How Morningstar Size Premia Are Calculated
Morningstar Size Premia Are “Beta Adjusted”
How Duff & Phelps Size Premia Are Calculated
Duff & Phelps Size Premia Are “Beta Adjusted”
Duff & Phelps “Risk Premia over the Risk-free Rate”
INTRODUCTION
In Chapter 9 on the build-up method and Chapter 10 on the capital asset pricing model (CAPM), we made reference to the “size effect.” The size effect is based on the empirical observation that companies of smaller size are associated with greater risk and, therefore, have a greater cost of capital. While the size effect is a factor in other cost of capital models—for example, the Fama-French three-factor model (see Chapter 18)—in this chapter we discuss evidence of the size effect and its measurement in the context of the build-up method and the CAPM.
In this chapter we focus on the empirical evidence of the size effect provided by two independent sets of studies: the Morningstar studies and the Duff & Phelps studies.2,3
Both the Morningstar and Duff and Phelps studies examine the ...
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