Size effect, book-to-market effect, and survival

Previous studies find that small stocks have higher average returns than large stocks, and the difference between the returns can not be accounted for by the systematic risk, b. In my analysis of Compustat and CRSP data from 1976 to 1995, and simulation experiments based on the data, I find the size effect can be largely explained by data truncation that is caused by survival. Small stocks’ returns are more volatile, and small stocks are more likely to go bankrupt and less likely to meet the stock exchanges’ minimum capitalization requirements for listing. As a result, they are more likely to drop out of the sample. Including small stocks that do well and excluding those that do poorly, ex post, gives rise to higher returns for small-size portfolios. I conclude that the size effect is largely a spurious statistical inference resulting from survival bias, not an asset pricing ‘anomaly’. © 2000 Elsevier Science B.V. All rights reserved. JEL classification: G12; G14