Recent studies report that the size effect in the cross-section of stock returns has disappeared after the early 1980s. This paper shows that the disappearance of the size effect from realized returns can be attributed to unexpected shocks to the profitability of small and big firms. We find that small firms experience large negative profitability shocks after the early 1980s, while big firms experience large positive shocks. As a result, realized returns of small and big firms over this period differ substantially from expected returns. After adjusting for the price impact of profitability shocks, we find that there still is a robust size effect in the cross-section of expected returns. Our results highlight the importance of in-sample cash flow shocks for understanding cross-sectional return predictability.

Additional Metadata
Keywords size effect, expected stock returns, profitability shocks, asset pricing tests
JEL Asset Pricing (jel G12), Information and Market Efficiency; Event Studies (jel G14), Accounting (jel M41)
Persistent URL hdl.handle.net/1765/76126
Note Fisher College of Business WP 2010-03-001; Dice Center WP 2010-1
Citation
Hou, K, & van Dijk, M.A. (2010). Resurrecting the size effect. Retrieved from http://hdl.handle.net/1765/76126