Evaluating the risk and return of size premiums.
The size premium, also known as size factor or size effect, in stock returns is the phenomenon that small-cap stocks on average outperform large-cap stocks over time. Therefore, the size premium can be inferred by the portfolio return difference between a small-sized and a large- sized portfolio (i.e., small minus big). In this assignment, you will evaluate the performance of the size premium across the globe. Professor Kenneth French is one of the authors in Fama and French’s (1993) three-factor model that incorporates a size premium. In his data library, he has shared historical returns for various asset classes and portfolios, including the size premiums. In the Excel file titled ‘Global Market Risk Premium and Size Premiums across Regions’ attached to this assignment, you are given the monthly size premiums across six regions/countries as of past 30 years (July 1992 – June 2022):
1. 1) Developed
2. 2) Emerging
3. 3) Europe
4. 4) Japan
5. 5) Asia-Pacific Excluding Japan
6. 6) North America
That is, the number in each cell indicates the monthly size premium for that particular country/region. You are also given the monthly market risk premium of global market, named ‘Global Market’.
Based on the Excel spreadsheet indicated above, perform the following tasks. You are encouraged to use Excel to perform the analyses. However, your analyses and discussion of findings must be presented as a report in a Word/PDF format. The word limit for the report is 1,500 words (with +/-10% leeway), excluding Executive Summary, Table of Contents, Tables, Figures, and References.
Requirements (Allocated Marks)
1) Calculate the time-series average returns and standard deviations to the size premiums across the six regions/countries. You should also consider the reward to risk ratios calculated as premium divided by standard deviation. Over the sample period and regions/countries considered, do you think that size matters in investment strategy? (20 marks)
2) Calculate the time-series average returns and standard deviations to the global market risk premiums. Compare the performance of those size premiums in part (1) with the global market risk premium over the same period. Do they outperform or underperform the market? (5 marks)
3) Examine the time-series return pattern of these size premiums. Are there any specific periods in which the size premiums outperform or underperform? Based on the time-series return pattern, do you think market condition (e.g., boom or recession) plays a role in explaining the return variation for the size premiums? (20 marks)
4) Conduct some literature review on academic articles on the size premiums. Based on your review, identify two potential theories/reasons why small firms may outperform large firms. Also, review the findings on past literature conducted on size premiums in the regions/countries above. Is your finding consistent with the extant literature? (35 marks)
6) Structure and presentation of the report including referencing. (10 marks) 7) Writing style and grammar. (10 marks)
Report writing tips
Report writing tips are available as follows. You are expected to submit your assignment in a professional business report, with workings attached to the Appendix.
You are expected to use sufficient academic references, such as peer-reviewed journal articles and books. Please avoid using Wikipedia or Investopedia.