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Predictable Dynamics in the Small Stock Premium

Last Updated on 10 February, 2024 by Rejaul Karim

The study “Predictable Dynamics in the Small Stock Premium” unearths compelling insights into the intricate interplay of factors influencing the mean monthly return on the Small-Minus-Big (SMB) Fama-French factor.

Authored by Valeriy Zakamulin, the paper meticulously dissects the impact of the January effect and the preceding month’s stock market return on the monthly SMB factor return, ultimately crafting a predictive model that encapsulates these influences.

Notably, the study’s findings offer illuminating observations, pointing to the predominance of a positive small stock premium in the aftermath of years marked by a negative market return, reflecting the delayed and intensified response of small stocks to positive news and a heightened January effect.

Furthermore, the paper challenges prior assumptions by delineating the diminished role of the January effect in constituting the size effect, shedding new light on the dynamics of stock return predictability.

Abstract Of Paper

We start this paper by providing a detailed study of how the mean monthly return on the Small-Minus-Big (SMB) Fama-French factor is affected by the January effect and the stock market return during the preceding month and preceding calendar year. We then proceed to building a predictive model for the monthly SMB factor return that incorporates the January effect and the dependence on both the market return during the preceding month and preceding calendar year. Our findings suggest that a positive small stock premium appears mainly during the years following the years with a negative return on the market as the result of a delayed and stronger reaction of small stocks to good news and a stronger January effect. We also argue that the January effect constitutes a much lesser part of the size effect than it was previously supposed.

Original paper – Download PDF

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Author

Valeriy Zakamulin
University of Agder – School of Business and Law

Conclusion

In closing, the study “Predictable Dynamics in the Small Stock Premium,” authored by Valeriy Zakamulin, yields valuable insights into the factors shaping the mean monthly return on the Small-Minus-Big (SMB) Fama-French factor.

Through a meticulous analysis, the paper constructs a predictive model for the monthly SMB factor return, incorporating the influence of the January effect and the preceding market returns.

The study’s findings compellingly indicate that the prevalence of a positive small stock premium is predominantly observed in the years following negative market returns, reflecting the delayed and intensified response of small stocks to positive news and reinforcing the influence of the January effect.

Furthermore, the paper challenges conventional wisdom, shedding new light on the diminished role of the January effect in constituting the size effect, ultimately enriching our understanding of stock return predictability.

Related Reading:

Forecasting the Size Premium Over Different Time Horizons

When Low Beats High: Riding the Sales Seasonality Premium

FAQ

What are the key factors influencing the mean monthly return on the Small-Minus-Big (SMB) Fama-French factor, according to the study?

The study identifies two key factors influencing the mean monthly return on the Small-Minus-Big (SMB) Fama-French factor: the January effect and the stock market return during the preceding month and preceding calendar year. The analysis delves into the impact of these factors on the monthly SMB factor return, providing a detailed examination of their interplay and influence on stock return dynamics.

What does the study reveal about the relationship between the small stock premium and market returns in the preceding years?

The study’s findings suggest that a positive small stock premium is more prevalent during the years following periods with a negative return on the overall market. This pattern reflects the delayed and intensified response of small stocks to positive news, highlighting the influence of preceding market conditions on the dynamics of the small stock premium. The study provides insights into the temporal dynamics of the small stock premium in relation to broader market trends.

How does the paper challenge prior assumptions regarding the January effect’s role in constituting the size effect?

The paper challenges prior assumptions by suggesting that the January effect constitutes a much lesser part of the size effect than previously supposed. By delineating the diminished role of the January effect in constituting the size effect, the study contributes to a reevaluation of the factors driving the small stock premium. This reexamination enriches our understanding of stock return predictability and the nuanced dynamics involved in the size effect.

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