Performance Evaluation of Small- and Large-cap stocks - The importance of size effects on the Swedish equity market

Abstract

This Bachelor´s thesis investigated the performance of small-cap stocks and large-cap stocks on the Swedish equity market (NASDAQ OMX) over the years 2011 to 2016. A number of studies focused on asset pricing have during the last decades indicated that the original Capital Asset Pricing Model (CAPM) is misspecified and has limited power to explain cross-sectional and temporal variations in expected equity returns. Moreover, equity returns have been suggested to, at least partially, be influenced by market anomalies e.g. associated with firm size (the size effect). Multi-factor pricing models such as the Fama-French Three-factor model and the Carhart Four-factor model are financial instruments developed to account for market anomalies such as firm size. In this study, single- and multi-factor pricing models were used to quantitatively evaluate the importance of the size effect for equity returns in two composite portfolios based on market capitalization. When analyzing the equity returns generated by small-cap stocks and large-cap stocks compared to the market benchmark (OMXSGI), on average, the small-cap stock portfolio outperformed both the market benchmark and the large-cap stock portfolio. However, the relative stock performance and relation between the equity returns of the two portfolios and the market benchmark varied significantly with time. Although not statistically significant, Fama-French Three-factor regressions generated alpha-values that indicated equity returns higher than those of the market for the small-cap stock portfolio, and equity returns lower than those of the market for the large-cap stock portfolio. Similar patterns were observed using the Carhart Four-factor model. Further, SMB-values from Fama-French Three-factor and Carhart Four-factor modelling indicated a positive risk-premium for holding small-cap stocks and a negative risk-premium for holding large-cap stocks. The SMB-values were statistically significant, thus, single- and multi-factor regression analyses suggested a size effect for the small-cap and large-cap portfolios. In contrast to indications of a general size effect, however, the predictive ability was not drastically different between the three asset pricing models. Although the present study provided empirical support that suggested a negative correlation between firm size and expected equity return, it also supported that additional factors, perhaps correlated with size, likely were important for the observed stock performance.