Firm Size and Cyclical Variations in Stock Returns

Abstract

Recent imperfect capital market theories predict the presence of asymmetries in the variation of small and large firms' risk over the economic cycle. Small firms with little collateral should be more strongly affected by tighter credit market conditions in a recession state than large, better collateralized ones. This paper adopts a f lexible econometric model to analyze these implications empirically. Consistent with theory, small firms display the highest degree of asymmetry in their risk across recession and expansion states, which translates into a higher sensitivity of their expected stock returns with respect to variables that measure credit market conditions.

Market timing and return prediction under model instability

“…On the other hand, if the parameters of the regression model are not believed to be constant over time, frequently a rolling window of observations 4 See the references in footnote 1. Studies that allow the regression model (but not the window size) to change over time include Timmermann (1995,2000) and Perez-Quiros and Timmermann (2000).…”

Revisiting the empirical linkages between stock returns and trading volume

“…First, cyclical variations in stock returns are widely reported in the literature. See, for example, Hamilton andLin (1996), andPerez-Quiros andTimmermann (2000). Thus, it is empirically evident that nonlinear models of the stock return with switches across bull and bear market regimes fit the data better than do linear models.…”

A Theory of Financing Constraints and Firm Dynamics

“…Gertler and Gilchrist [17] argue that liquidity constraints may explain why small manufacturing firms respond more to a tightening of monetary policy than do larger manufacturing firms. PerezQuiros and Timmermann [24] show that in recessions smaller firms are more sensitive to the worsening of credit market conditions as measured by higher interest rates and default premia. For surveys see Hubbard [21] and Stein [29].…”