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The size premium as a lottery

The size premium as a lottery
The size premium as a lottery
We investigate empirically the dependence of the size effect on the top performing stocks in a cross-section of risky assets separated by industry. We propose a test for a lottery-style factor payoff based on a stochastic utility model for an under-diversified investor. The associated conditional logit model is used to rank different investment portfolios based on size and we assess the robustness of the ranking to the inclusion/exclusion of the best performing stocks in the cross-section. Our results show that the size premium has a lottery-style payoff and is spurious for most industries once we remove the single best returning stock in an industry from the sample each month. Analysis in an asset pricing framework shows that standard asset pricing models fail to correctly specify the size premium on risky assets when industry winners are excluded from the construction of the size factor. Our findings have implications for stock picking, investment management and risk factor analysis.
1351-847X
1-20
Mcgee, Richard J.
93f5c00c-a866-4e35-997e-60b817f40497
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e
Mcgee, Richard J.
93f5c00c-a866-4e35-997e-60b817f40497
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e

Mcgee, Richard J. and Olmo, Jose (2019) The size premium as a lottery. European Journal of Finance, 1-20. (doi:10.1080/1351847X.2019.1644360).

Record type: Article

Abstract

We investigate empirically the dependence of the size effect on the top performing stocks in a cross-section of risky assets separated by industry. We propose a test for a lottery-style factor payoff based on a stochastic utility model for an under-diversified investor. The associated conditional logit model is used to rank different investment portfolios based on size and we assess the robustness of the ranking to the inclusion/exclusion of the best performing stocks in the cross-section. Our results show that the size premium has a lottery-style payoff and is spurious for most industries once we remove the single best returning stock in an industry from the sample each month. Analysis in an asset pricing framework shows that standard asset pricing models fail to correctly specify the size premium on risky assets when industry winners are excluded from the construction of the size factor. Our findings have implications for stock picking, investment management and risk factor analysis.

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Sizepremium_McGee_Olmo - Accepted Manuscript
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More information

Accepted/In Press date: 9 July 2019
e-pub ahead of print date: 22 July 2019

Identifiers

Local EPrints ID: 433018
URI: https://eprints.soton.ac.uk/id/eprint/433018
ISSN: 1351-847X
PURE UUID: adeb82e9-f978-4ec3-9029-c622c14be862
ORCID for Jose Olmo: ORCID iD orcid.org/0000-0002-0437-7812

Catalogue record

Date deposited: 06 Aug 2019 16:30
Last modified: 30 Nov 2019 01:32

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