Does size matter?: An empirical study modifying Fama & French's three factor model to detect size-effect based on turnover in the Swedish markets
Independent thesis Basic level (degree of Bachelor), 10 credits / 15 HE creditsStudent thesisAlternative title
Spelar storleken roll? : En empirisk studie med Fama & French:s tre-faktor modell modifierad för att undersöka storlekseffekt baserat på omsättning på den svenska marknaden (Swedish)
This thesis investigates whether the estimation of the cost of equity (or the expected return) in the Swedish market should incorporate an adjustment for a company’s size. This is what is commonly known as the size-effect, first presented by Banz (1980) and has later been a part of models for estimating cost of equity, such as Fama & French’s three factor model (1992). The Fama & French model was developed based on empirical research. Since the model was developed, the research on the size-effect has been divided and today there are empirical studies contradicting its existence. Arguments against the size-effect are to some extent supported by the fact that there is no solid theoretical explanation for it. It seems however that market participants in the Swedish markets do adjust for the size.A limitation of the Fama & French model is that market data is required for the estimation. Our starting point is to investigate if there is a presence of the size-effect in the Swedish markets using a modified version Fama & French model. In our modified model a proxy for the market value of the firm has been introduced, namely the firms turnover. This is motivated by the fact data regarding a company’s turnover is available for private firms as well. In the case that size-effect is observable using the turnover as a proxy this would allow to extend the model to estimate the cost of equity for private firms. In the case where a consistent estimated marginal effect of the turnover is observed, our model could be used to estimate cost of equity with reasonable precision.
Historical data on Swedish companies from each of the OMX Large, Mid & Small cap lists is used in a regression setting to investigate if any statistical significant results can be observed on whether the logarithm of the turnover affects the expected return.Our results indicate that the marginal effect of the turnover is positive, contradicting previous research and economic intuition that size of a company should be negatively correlated (or uncorrelated) with the expected return. By investigating the internal and external validity of the results, comparison to previous research and assessing data quality, we conclude that errors originating from these factors are not plausible to cause the unintuitive results. We therefore conclude that the use of turnover as a proxy for market value is not viable, which may be attributed to the fundamental relationship between the turnover and cost of equity in valuation formulas.
Conclusively we cannot draw any further conclusions regarding presence of size-effect in the Swedish equity markets and discard the possibility of using our modified model for estimating cost of equity for private firms.
Place, publisher, year, edition, pages
2014. , 57 p.
Fama & French, Swedish markets
IdentifiersURN: urn:nbn:se:liu:diva-117836ISRN: LIU-IEI-FIL-G--14/01164--SEOAI: oai:DiVA.org:liu-117836DiVA: diva2:811128
Subject / course
Bachelor Thesis in Economics
Hägg, Göran, Universitetslektor
Andersson, Peter, Universitetslektor