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Resurrecting the Size Effect: Firm Size, Profitability Shocks, and Expected Stock Returns

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  • Kewei Hou
  • Mathijs A van Dijk
  • Laura StarksEditor

Abstract

Many studies report that the size effect in the cross-section of stock returns disappeared after the early 1980s. This paper shows that its disappearance can be attributed to negative shocks to the profitability of small firms and positive shocks to big firms. After adjusting for the price impact of profitability shocks, we find a robust size effect in the cross-section of expected returns after the early 1980s. Our results highlight the importance of in-sample cash-flow shocks in understanding cross-sectional return predictability.Received April 2, 2014; editorial decision August 6, 2018 by Editor Laura Starks.

Suggested Citation

  • Kewei Hou & Mathijs A van Dijk & Laura StarksEditor, 2019. "Resurrecting the Size Effect: Firm Size, Profitability Shocks, and Expected Stock Returns," The Review of Financial Studies, Society for Financial Studies, vol. 32(7), pages 2850-2889.
    • Handle: RePEc:oup:rfinst:v:32:y:2019:i:7:p:2850-2889.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhy104
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    Cited by:

    1. Hendershott, Terrence & Livdan, Dmitry & Rösch, Dominik, 2020. "Asset pricing: A tale of night and day," Journal of Financial Economics, Elsevier, vol. 138(3), pages 635-662.
    2. Rudiawarni, Felizia Arni & Sulistiawan, Dedhy & Sergi, Bruno S., 2024. "The role of the net purchase of stocks by foreign investors in boosting stock returns: Evidence from the Indonesian stock market," Economic Modelling, Elsevier, vol. 135(C).
    3. Lin, Qi & Lin, Xi, 2019. "Expected profitability and the cross-section of stock returns," Economics Letters, Elsevier, vol. 183(C), pages 1-1.
    4. Daye Li & Tianyang Li & Kefu Yi & Yitong Liu, 2022. "Size effect and the measurement of firm size," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 43(4), pages 894-905, June.
    5. Bao, Jack & Hou, Kewei & Zhang, Shaojun, 2023. "Systematic default and return predictability in the stock and bond markets," Journal of Financial Economics, Elsevier, vol. 149(3), pages 349-377.
    6. Yin, Libo & Liao, Huiyi, 2021. "Big is brilliant: Understanding the Chinese size effect through profitability shocks," International Review of Financial Analysis, Elsevier, vol. 74(C).
    7. Zhao, Xiaojuan & Wang, Ye & Liu, Weiyi, 2024. "Someone like you: Lottery-like preference and the cross-section of expected returns in the cryptocurrency market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 91(C).
    8. Jansen, Maarten & Swinkels, Laurens & Zhou, Weili, 2021. "Anomalies in the China A-share market," Pacific-Basin Finance Journal, Elsevier, vol. 68(C).
    9. Naresh Bansal & Robert A. Connolly & Chris Stivers, 2022. "Beta and size equity premia following a high‐VIX threshold," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(8), pages 1491-1517, August.
    10. Peter S. Schmidt & Urs von Arx & Andreas Schrimpf & Alexander F. Wagner & Andreas Ziegler, 2019. "Common risk factors in international stock markets," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 33(3), pages 213-241, September.
    11. Qi Lin, 2020. "Idiosyncratic momentum and the cross‐section of stock returns: Further evidence," European Financial Management, European Financial Management Association, vol. 26(3), pages 579-627, June.
    12. Zhi Su & Danni Wu & Zhenkun Zhou & Junran Wu & Libo Yin, 2023. "The Impact of Customer Online Satisfaction on Stock Returns: Evidence from the E-commerce Reviews in China," Papers 2306.12119, arXiv.org.
    13. Frye, Melissa B. & Gatchev, Vladimir A. & Pham, Duong T., 2024. "Director self-dealing: Evidence from compensation peer groups," Journal of Corporate Finance, Elsevier, vol. 85(C).
    14. Cheema, Muhammad A. & Chiah, Mardy & Zhong, Angel, 2021. "Resurrecting the size effect in Japan: Firm size, profitability shocks, and expected stock returns," Pacific-Basin Finance Journal, Elsevier, vol. 69(C).
    15. Wan, Die & Yang, Teng & Yang, Xiaoguang, 2021. "IPO relative difficulty, M&A option and size effect," Journal of Asian Economics, Elsevier, vol. 76(C).
    16. Guo, Laite, 2023. "Two faces of the size effect," Journal of Banking & Finance, Elsevier, vol. 146(C).

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