Portfolio Design: A Modern Approach to Asset Allocation

RELATIVE PERFORMANCE OF LARGE-CAP AND SMALL-CAP STOCKS—SBBI SERIES

It is important to investigate whether the relative performance of small-cap stocks is due to the particular sample period selected. The Russell data provide 31 years of evidence beginning in 1979. For most of the sample period beginning in 1979, the U.S. economy was booming and U.S. stocks were in a sustained rally from the lows of the 1970s. Interest rates, after hitting a peak in 1981, fell for most of the next 30 years. So perhaps there is something unusual about the recent period that limits the small-cap premium.

To investigate this possibility, we turn to the SBBI series to study returns for the longer period. The SBBI small-cap series begins in 1926, but as in the previous chapter we will begin the analysis in 1951. Table 3.6 reports the basic statistics for the SBBI small-cap series (previously described) and the SBBI large-cap series for 1951 to 2009. The results are quite different than those reported for the Russell series. The SBBI small-cap index has a return that is 2.4 percent above that of the large-cap index. As discussed above, this small-cap premium inspired research studies in the early 1980s which were among the first to criticize the standard capital asset pricing model. Two studies, by Banz (1981) and Reinganum (1981) are especially notable, the latter describing the small-cap premium as an anomaly.

Figure 3.2 shows the yearly excess returns for small caps over large caps. It is evident from ...