SIZE EFFECT ON STOCK RETURNS IN

SRI LANKAN CAPITAL MARKET

Mr. MIM. Riyath
Dr. A. Jahfer
Background of the study
Sharpe (1964) and Lintner (1965) version of
Capital Asset Pricing Model (CAPM)

•Ε𝑅𝑖𝑡 = 𝑅𝑓𝑡 + 𝛽𝑖 Ε𝑅𝑚𝑡 − 𝑅𝑓𝑡

Market factor is the only factors which determine
variations of expected return of stocks.
Test of CAPM
Beta and Return - Positive relationship
Black, 1972;
Black, Jensen & Scholes, 1972;
Douglas, 1967;
Fama & MacBeth, 1973;
Miller & Scholes, 1972;
Stambaugh, 1982
Test of CAPM
Beta and Return – No / Weak relationship
Davis, 1994;
Fama & French, 1992, 1993, 1996;
Grinold, 1993;
Lakonishok & Shapiro, 1984;
Alles and Murray, 2008;
 Nimal, 1997;
Samarakoon, 1997
 Size Effect
Banz (1981) –
• Firm size is able to determine the variations of
expected return of stocks.
• Negetive liner relationship
• The stocks with smaller market capitalization earn
higher return than stock with bigger market
capitalization .
• The return differences between smaller and bigger
market capitalization is known as size premium.
Evidences in US market
Reinganum (1981),
Bhandari (1988),
Lamoureux and Sanger (1989) and
Fama and French (1992)
Evidences in International market

Herrera and Lockwood (1994) in Mexican Stock

Market;
Dimson and Marsh (1984), Levis (1985) and Mills
and Jordanov (2001) in London Stock Exchange;
Heston, Wessels and Rouwenhorst (1999) in
European countries;
Hodoshima, Garza–Gómez and Kunimura (2000) in
Japanese market;
Wahlroos and Berglund (1986) in Finland and
Elfakhani, Lockwood and Zaher (1998) in Canada.
Research Problem

US
Europe
Japan
International Market

Sri Lanka ???????

Research Question and Objective

Research Question
Is size effect exist in Sri Lankan
capital market?

Research Objective
 To test weather size effect is exist or
not in Sri Lankan capital market.
Methodology

Sample
All companies listed in CSE, except Bank Finance
and Insurance sector.
188 companies for 156 month = total observations
is 29328.
Excluding missing value – 25349
Study Period
From April 2000 to March 2013 – 156 Months.
Operationalization of Variables

𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 / Firm size =

number of shares outstanding x closing price
as at end of last trading day of year end

𝑃𝑡 𝑃𝑐 (1 + 𝑅𝑟 + 𝑆𝑟 + 𝐵𝑟 + 𝐷𝑟 )
𝑅𝑖𝑡 = − 1 𝑋 100
𝑃0 𝑃𝑐 + 𝑅𝑟 𝑃𝑟
Portfolio Formation
Each March year t, the sample of stocks sorted in ascending
order based on firms’ Market Capitalization.
Divided into five equal number of portfolios; Q1, Q2….Q5.
Q1 – Smallest Market Capitalization stocks
Q5 - Biggest Market Capitalization stocks
Return - The equally weighted monthly Return
From April t to March t+1.
Then the portfolios rearranged in every March t+1
Number of Stocks in each portfolio as at March t

Number of Stocks
Year Q1 Q2 Q3 Q4 Q5
2000 33 34 34 31 36
2001 35 32 35 32 35
2002 33 35 36 33 36
2003 34 38 36 33 37
2004 35 39 38 34 37
2005 37 39 37 36 39
2006 39 39 39 39 38
2007 38 40 40 38 37
2008 37 40 39 38 36
2009 37 39 39 38 38
2010 67 39 38 39 39
2011 67 39 38 39 39
2012 38 39 37 38 38
 Average Market Capitalization
of each portfolio as at March t (in Million Rupees)

Average Market Capitalization in Million Rupees

Year D1 D2 D3 D4 D5
2000 18.36 73.52 170.07 324.59 1444.79
2001 17.44 62.80 133.85 255.49 1202.63
2002 27.52 106.45 230.17 445.20 2451.34
2003 36.88 146.39 321.29 737.44 7750.58
2004 65.71 205.98 448.44 995.60 6167.20
2005 118.92 335.28 725.75 1630.40 13262.66
2006 120.28 344.05 784.24 1541.93 12954.61
2007 117.44 343.34 762.10 1556.47 15389.12
2008 132.58 367.67 799.35 1800.27 12216.89
2009 151.66 444.92 1016.82 2365.65 15820.50
2010 311.04 1060.51 2559.04 5507.90 35684.82
2011 529.65 1369.81 2705.52 5865.61 34207.45
2012 394.22 1078.58 2115.15 4757.89 33626.31
Average Monthly Return from April t to March t+1

Average Monthly Return

Year Q1 Q2 Q3 Q4 Q5
2000 -0.4393 0.6496 -0.5344 -0.1855 0.0406
2001 7.0468 4.7628 3.1479 5.0925 4.3045
2002 3.4928 2.7459 2.3954 2.7601 2.9049
2003 7.9840 3.7400 2.9964 6.1806 6.6947
2004 12.8148 7.4714 7.5121 6.7526 3.6788
2005 3.0386 2.5225 3.2725 3.6413 3.0152
2006 0.8927 -0.4935 1.0861 4.0667 1.5444
2007 4.9886 2.9376 4.1660 2.1700 0.7101
2008 -1.2859 -0.6867 -2.1638 -0.7234 -1.2293
2009 6.8801 7.6411 8.1413 9.1371 9.3624
2010 8.3658 13.1802 8.7671 8.3953 6.4695
2011 -0.7306 -1.6616 -1.5500 -2.3375 -1.0375
2012 0.7160 -0.1619 0.2202 0.6197 0.9482
Descriptive statistics of each portfolio

Descriptive Statistics
Statistic Q1 Q2 Q3 Q4 Q5
No. of observations 156 156 156 156 156
Mean 4.14 3.29 2.90 3.50 2.87
Median 2.13 1.44 2.12 2.05 1.76
Minimum -28.01 -20.85 -21.48 -19.68 -17.48
Maximum 60.32 63.48 38.72 30.71 29.89
Range 88.33 84.32 60.19 50.39 47.37
Standard deviation (n-1) 12.13 11.19 9.58 9.43 8.15
Standard error of the mean 0.97 0.90 0.77 0.75 0.65
Mean absolute deviation 8.99 7.94 7.27 7.39 6.17
Test of Relationship
𝐻0 : there is no relationship between stock return and size

𝐻1 : there is a relationship between stock return and size

𝐻0 ∶ 𝜌 = 0
𝐻1 ∶ 𝜌 ≠ 0
 Correlations Analysis
Variables Pearson Correlation Sig

Ln Market Equity
and
Monthly Return
-0.12 0.0235*
*Correlation is significant at the 0.05 level

𝐻0 ∶ 𝜌 = 0
𝐻1 ∶ 𝜌 ≠ 0
Fama and MacBeth (1973) Test

To estimate impact of risk factor on

asset return

𝐻0 ∶ 𝛾𝑡ҧ = 0

𝐻1 ∶ 𝛾𝑡ҧ ≠ 0
Fama and MacBeth (1973) Test procedure

 1st stage : TS
Estimate the slope coefficient for each of the 5
portfolios using time series regression across
portfolios.

 2nd stage : CS
Portfolio returns regressed against the 5 estimated
slope coefficient across time periods.
Fama and Macbeth (1973) Regression

1st step time series regression

𝑅𝑖𝑡 = 𝛼𝑖𝑡 + 𝛽𝑖𝑡 𝑀𝐸𝑖𝑡

2nd step cross sectional regression

𝑅𝑡 = 𝛾0𝑡 + 𝛾1𝑡 𝛽𝑡
Fama and Macbeth (1973) coefficient

Time series average of cross section

coefficient
𝑇
1
𝛾 = ෍ 𝛾𝑡
𝑇
𝑡=1
Fama and Macbeth (1973) t Test
statistics

𝜸𝒌
𝒕 𝜸𝒌 =
𝒔𝒅 𝜸𝒌
𝑻

𝑇
1 2
𝜎= ෍ ( 𝛾 − 𝛾𝑡 )
𝑇2
𝑡=1
 Fama and Macbeth (1973) Test
FM Coefficient -0.27286
Observation 156
Variance 0.121009

SD 0.347863

T Statistics FM
-9.79717
Hypothesis
T Statistics FM -9.79717

𝐻0 ∶ 𝛾𝑡ҧ = 0

𝐻1 ∶ 𝛾𝑡ҧ ≠ 0
Hypothesis for Value premium

𝑯𝟎 : Size premium is not exist in the Colombo stock market.

𝑯𝟏 : Size premium is exist in the Colombo stock market.

𝐻0 : 𝑥ҧ𝑄5 ≥ 𝑥ҧ𝑄1
𝐻1 : 𝑥ҧ𝑸𝟓 < 𝑥ҧ𝐐𝟏
Samples Statistics
Samples Statistics

Std. Error
Mean N Std. Deviation
Mean
Q1 4.1410 156 15.90990 1.27381

Q5 2.8661 156 14.87861 1.19124

Size Premium
Differences

Std. Std. Error t df Sig.

Mean
Deviation Mean

Q1 - Q10 1.2748 9.5885 0.76769 1.661 155 0.040406

𝐻0 : 𝑥ҧ𝑄5 ≥ 𝑥ҧ𝑄1
𝐻1 : 𝑥ҧ𝑄5 < 𝑥ҧ𝑄1
 Conclusion
There is a weak negative relationship is exist
between stock return and firm Size exist in
Colombo stock exchange during the study period.
The size effect is exist in Colombo stock exchange
during the study period.
There is a significant size premium is exist in
Colombo stock exchange during the study period.