Size effect, methodological issues and 'risk-to-default': Evidence from the UK stock market

This paper re-examines the small firm premium in the UK from December 1987 to December 2004 using a new survivorship bias-free and look-ahead bias-free database of the UK market covering stocks officially listed in the UK during this period. Prior research (Dimson, E., and P.R. Marsh. 1987. The Hoare Govett smaller companies index for the UK. Hoare Govett Limited, January; Dimson, E., and P.R. Marsh. 1999. Murphy's law and market anomalies. Journal of Portfolio Management 25, no. 2: 53-69) documented an annual small-size premium in the UK market of around 6% during the period 1955-1986 and an annual small-size discount of 6% during the years 1989-1997. Our results show a continuation of the small firm premium in the UK during 1988-2004 in excess of 7% per year. We conclude that the reversal of the small firm premium documented by Dimson and Marsh (1999. Murphy's law and market anomalies. Journal of Portfolio Management 25, no. 2: 53-69) is dependent on the data sample and methodology used. The main contribution to the 7%+geometric annual premium reported here comes mainly during the years 1993 and 1999. Furthermore, exploitation of the small firm premium depends on the strategy used and in particular on the length of the holding period before rolling over the strategy. Thus, while it can be argued that an economically significant small firm anomaly continues to exist, it appears to be sample-dependent, time-varying and unreliable, and difficult to exploit in practice.