Journal of Banking and Finance North-Holland zyxwvutsrqponmlkjihgfedcbaZYXWVU 13 (1989) 675-696. STOCK MARKET A Re-assessment ANOMALIES Based on the UK Evidence Mario LEVIS* University Received September of Bath, Bath BA2 7AY, UK 1988, final version received June 1989 This paper reports evidence documenting the presence of a number of irregularities in stock price behaviour of firms on the London Stock Exchange. The size effect is not only not the sole anomaly but is not even the most dominant one. Specifically, investment strategies based on dividend yield, PE ratios and share prices appear as profitable, if not more, as a strategy concentrating on firm size. Although there is a large degree of interdependency between all four effects, it is still apparent that the dividend yield and PE ratios subsume the size and share price effects. 1. Introduction The volume of empirical evidence that followed Banz’s (1981) and Reinganum’s (1981) seminal papers has firmly established the existence of a market size anomaly in stock price behaviour. In the process of searching for explanations for this phenomenon a number of other ‘irregularities’ have surfaced. The discovery of the January effect, for example, provided further valuable insight into the size anomaly but in effect added to rather than resolved the puzzle. Furthermore, it seems that investment strategies based on earnings or dividend yields have earned, over sufficiently long time periods, positive and significant abnormal returns. The presence of such anomalies is not confined to the U.S. market alone.’ Evidence of the size effect for other markets has been less forthcoming, but the results of Brown, Kleidon and Marsh (1983) for the Australian market, Berges, McConnell and Schlarbaum (1984) for Canada, Nakamura and Tarada (1984) for the Tokyo Stock Exchange and Levis (1985) for the London Stock Exchange (LSE) point to a similar size anomaly in these markets as well. With regard to the *An earlier version of this paper was presented at the NATO Advanced Research Workshop at Sesimbra, Portugal in April 1988. I gratefully acknowledge the comments of the workshop participants. ‘See for example Gultekin and Gultekin (1983). 0378-4266/89/$3.50 0 1989, Elsevier Science Publishers B.V. (North-Holland) 676 M. Levis, zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONM Stock market anomalies dividend and earnings yield effects the evidence for other than the U.S. market is still scarce. The main question surrounding these findings is whether such additional anomalies are independent of or related to market size. The evidence on this issue is rather controversial. While Reinganum (1981) and Banz and Breen (1986) argue that the size effect subsumes the PE effect, Basu (1983) asserts quite the opposite - i.e. size related anomalies disappear when one controls for the PE effect. Cook and Rozeff’s (1984) investigation of this discrepancy added to the controversy by concluding that both views are misguided; their work suggests that ‘both effects (at least) are at work’ (p. 464). In a more recent paper Jaffe, Keim and Westerfield (1988) reached similar conclusions. Peavy and Goodman (1983) introduced an additional dimension to the analysis; they argue that the PE effect may in fact be an industry effect, since firms in the same industry tend to have similar PE multiples. When, however, a direct comparison between PE and firm size is undertaken, Goodman, Peavy and Cox (1986) conclude that size usually serves as a proxy for the PE effect. The relation between dividend yields and stock returns has also received close scrutiny in the academic literature. For example, the studies of Litzenberger and Ramaswamy (1979), Blume (1980), Gordon and Bradford (1980), Miller and Scholes (1982) and Elton, Gruber and Rentzler (1983) point to a positive and significant relation between dividend yield and returns but disagree about the underlying sources of this relation; while some attribute it to the disparity in the tax rates for divided yields and capital gains, others maintain that yield related effects are due to information bias. Keim’s (1985) evidence provides an alternative view; it indicates a strong interaction between dividend yield and firm size which suggests that the positive dividend yield-return relation is a direct result of the concentration of smaller firms in certain high dividend yield categories. As the common factor between the three variables - market size, PE multiples and dividend yields - is the share price, it is not inconceivable that these three effects may be attributed to some underlying relationship between share price and stock returns. The evidence of Blume and Husic (1973), Stoll and Whaley (1983) and Blume and Stambaugh (1983) points to a negative relation between share prices and stock returns. It appears that one of the main sources of the continuing controversy regarding the relative importance of the four documented anomalies is the fact that they have been investigated separately using different data sets and various methodologies. This paper provides a systematic examination of the stock price behaviour of firms on the LSE in search for evidence regarding the presence and possible interrelations of the market size, dividend yield, PE multiple and share price effects. Such an analysis is crucial not only because it provides for the first time a comprehensive evaluation of all four anomalies M. Levis, Stock market anomalies 611 using a unique set of data under a uniform methodology, but also because it offers the opportunity to contrast the U.S. stock price behaviour irregularities with that of one of the largest capital markets. If indeed it emerges that such phenomena are ‘market specific’, it would imply that application of conclusions drawn from one market to the other is unwarranted and even misleading. Nevertheless, the implications in terms of investment strategy and academic research have been already universally adopted.2 Section 2 describes the data and methodology used in this study. Section 3 examines the properties of the portfolios generated under the four ranking procedures, while sections 4 and 5 provide a detailed analysis of the four anomalies under investigation and their potential interactions respectively. Finally, the main conclusions of this study and its implications are outlined in section 6. 2. The data and methodology zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLK A. Data and portfolio formation procedures The data used in this study are from the London Share Price Database (LSPD) monthly returns tile and source tile. The latter provides the data required to estimate market value, PE multiples, dividend yields and share prices, while the former contains monthly rates of return, inclusive of dividends and capital gains. Market value of the firm is defined as the market price at the calendar year-end T (T= 1955,1956,. . . ,1983), times the number of shares outstanding. The dividend yield is measured by the ratio of the dividends paid during the twelve months period of a calendar year to the market price of common stock at the end of this year. Earnings per share are estimated as the twelve months earnings divided by the number of shares outstanding at the calendar year-end; this estimate over the share price at the end of the same year determines the PE ratio.3 In the first instance, a single classificatory procedure is used to construct portfolios for each of the four attributes under investigation. At the end of each calendar year T firms are ranked separately in ascending order according to market value, dividend yield, PE ratio and share price. Portfolio returns are then computed for the 12-month period commencing the following April, by combining returns of individual firms using equal ‘Dimson and Marsh (1986), for example, have made a strong case for the small size effect to be incorporated into the estimation of abnormal returns in event studies. 3This is the definition used by Reinganum (1981), Basu (1983) and Cook and Rozeff (1984). In case of firms with a calendar fiscal year-end this definition of dividend yield and PE ratio may incorporate a look-ahead bias. [See Banz and Breen (1986) and following note.] Ball’s (1978) evidence, however, indicates that the likely effects of experimental bias are not sufficient to explain the magnitude of the PE anomaly. 678 M. Levis, Stock market anomalies weights4 The ranking and portfolio formation procedures for each of the four attributes were repeated 29 times to cover the period April 1956 to March 1985. To qualify for inclusion in a given calendar year, a firm need only possess data for the particular ranking procedure at the end of this year and a valid rate of return for April of the following year. Every year firms enter or leave the sample due to merger or bankruptcies. Thus, no survival bias requirements are imposed on the sample. Given the ambivalent interpretation of negative earnings and following the practice of previous studies, a firm was dropped from the sample in any year in which it had negative earnings. A preliminary analysis of the data indicated substantial differences in data availability when earnings-per-share (eps) were considered. While, for example, the ranking procedures for market value, dividend yield and share price resulted in very similar sample sizes, ranging from 1,150 firms in the beginning of the 70’s to 2,300 in mid-70’s, the PE procedure resulted in a sample ranging from 770 to 1,920 firms. ’ The differences in the sample size would be unimportant for the purposes of this study if the missing eps data were occurring randomly across the quintiles of the four attributes. Since this was not the case, a direct comparison of the various effects utilising different sample sizes would be misleading; on the other hand, the adoption of a unified sample which could satisfy all four criteria in terms of data availability would result in an even greater reduction of the data set with undesirable consequences. Thus, the whole analysis is repeated using two data sets. The full sample is utilised when the market size, dividend yield and share price (or any combination of them) are used as the ranking procedures. On the other hand, where the PE ratio is involved, on its own or in combination with any of the other attributes, a reduced sample is used. Both sets of results are presented when comparisons among ranking procedures are in order. A simple MVl notation is used to identify the smaller size portfolio, based on the full sample, while MVl! denotes the same portfolio based on the reduced sample. To control for the interaction effects between the four attributes, combined portfolios are constructed. Both within-groups only and within-groups plus ‘Starting the calculation of portfolio returns in the following April minimises the potential bias of accumulating returns over a three-month period, at the beginning of each year, when the dividends and earnings assumed known in the dividend yield and PE calculations are in fact unknown. This is the method used by Basu (1983) and Cook and Rozeff (1984). To test, however, for the extent of this bias the whole analysis was repeated for portfolios running from January instead of April. ‘For the period January 1956 to December 1974 the sample of companies on the LSPD returns file IS somewhat biased towards larger firms. From January 1975 onwards the database has been extended to cover all listed shares on the London Stock Exchange [see Smithers (1986)]. Thus, the small firm effect reported in this study may be understated during the former period. On the other hand, it is worth noting that the increase in the size of the sample on January 1975 did not result to any significant change in the monthly rates of return of the various market size portfolios. M. Levis, Stock market anomalies 619 randomisation methods are used. According to the former, all firms in either the full or reduced sample were ranked first by a chosen criterion and quintiles are formed. Then within each quintile firms are reranked on a second variable and quintiles are formed within each of the original quintiles; twenty-five portfolios are formed for each combination of two attributes. The process was repeated 25 times to generate portfolios within each of the four characteristics used in this study as a primary variable and the remaining three as secondary grouping; to cover all possible combinations of attributes 300 (5 x 5 x 3 x 4) portfolios were generated. Within groups portfolios were created by ranking, for example, first on size and next on dividend yield, PE, and share price. The within-groups method has been used by Basu (1983), Banz (1981) and tested by Cook and Rozeff (1984). The within-groups plus randomisation method was also used by Basu (1983) and Cook and Rozeff (1984). The randomisation method follows from the within-groups method described above; the 25 portfolios generated for each combination of pairs are combined to form the randomised portfolios. Market size portfolios, for example, are constructed by randomising separately with respect to dividend yield, PE multiple and share price. The MVl *DV portfolio, for example, includes securities of the first market size quintile but is drawn from the entire set of dividend yield classes; thus it can be viewed as being randomised with respect to dividend yield. In a similar manner, portfolio zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFE DVl * MV contains firms of the lowest dividend yield but includes firms from all market size classes, i.e. randomised with respect to firm size. To cover all pairs of combinations of the four ranking procedures used in this study, 12 randomisation procedures were required, resulting in sixty randomised portfolios.‘j B. Risk adjustment issues Abnormal returns (u,,) are estimated by subtracting from the actual portfolio return (R,,) the returns predicted by the model used, given the market return (R,,), the risk free rate (Rft) and the parameter estimates (b,). Two main models were employed in this study: upt= (R,, - Rft) -Km - R,J (1) up,= (R,, - RJ,)- WLt - RI,). (2) Model (1) can be regarded as a limiting case of model (2), the simple CAPM framework, whereby all betas are assumed to be unity and the abnormal return is estimated by subtracting the market from the portfolio return. 6All within-groups only and within-groups plus randomisation portfolios that include the PE ratio either as a primary or secondary ranking variable are based on the reduced sample. All other portfolios utilise the full set of data available. M. Levis, Stock market anomalies 680 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA Model (2) involves a two-stage estimation procedure. The first stage consists of the estimation of the respective beta coefficients. A sixty month base period is used for this purpose; the first base period is April 1956 to March 1961. In the second stage the base period beta estimates are used to obtain abnormal returns for a subsequent holdout period. Holdout periods run for twelve months at a time beginning in April following the base year (April 1961 in the first instance) and running through March of the following year. Betas are updated annually by rolling over the base period twelve months at a time. Thus, the last base period is April 1979 to March 1984, while the last holdout period is April 1984 to March 1985. The total number of months in the holdout period is 288. Marsh (1979) concluded that the results are remarkably robust to the precise variant of the single factor Market Model and to the estimates of beta. They are, however, very sensitive to the choice of portfolio weighting scheme, so that quite different abnormal returns were obtained when equally rather than market value weighted indices were employed. Accordingly, abnormal returns in this study are estimated using a specially constructed equally weighted index consisting of all securities on the London Stock Exchange. Furthermore, given the well-documented problems of thin trading evident with U.K. data, abnormal returns based on model (2) but using the Dimson (1979) Aggregated Coefficients (AC) method for beta estimates were also estimated for all portfolios. Thus, model (2) takes the form: upr=(Rpt-Rf,)- ; bpdRm,t+k-Rf,t+k)- zyxwvutsrqponmlkjihgfedcbaZYX (3) k=- 1 Following Dimson, aggregated beta coefficients lagged and one leading market variable.7 are estimated using five 3. The properties of the four portfolio ranking procedures A. Rates of return Table 1 shows the monthly average raw rates of return for the quintiles generated by each of the four single ranking procedures over the period April 1961 to March 1985. Each panel also shows the standard deviation of the portfolio (column 2), the mean return per unit of standard deviation (column 4) and the difference between this amount and the corresponding values for the FTA value weighted and an equally weighted index, are shown in columns 5 and 6 respectively. These results are directly comparable with the evidence reported in U.S. studies. ‘Experimentation with a different lag structure indicated that AC beta estimates are robust around the number of lagging and leading variables adopted in this study. M. Levis, zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONM Stock market anomalies 681 Table 1 Monthly rates of return and other summary statistics for the full and reduced sample in the period April 1961 to March 198.5.” Mean (1) (3)-FTA (4) (3)-Equal (5) Part 1: Full sample A. Market value MVl MV2 MV3 MV4 MV5 1.32 1.19 1.00 0.94 0.90 3.85 4.60 5.26 5.76 6.32 0.343 0.259 0.190 0.163 0.142 0.174 0.090 0.021 -0.006 - 0.027 0.127 0.043 - 0.026 - 0.053 -0.074 B. Dividend yield DVl DV2 DV3 DV4 DV5 0.74 0.80 1.03 1.20 1.57 5.22 5.30 5.16 4.90 4.59 0.142 0.151 0.200 0.245 0.342 - 0.027 -0.018 0.031 0.076 0.173 - 0.074 - 0.065 -0.016 0.029 0.126 C. Share price PRl PR2 PR3 PR4 PR5 1.33 1.20 1.01 0.93 0.91 4.67 4.96 5.23 5.26 5.14 0.285 0.242 0.193 0.177 0.177 0.116 0.073 0.024 0.008 0.008 0.069 0.026 -0.023 -0.039 -0.039 MVl! MV2! MV3! MV4! MV5! 1.51 1.16 1.05 0.98 0.87 3.72 4.47 5.30 5.94 6.32 0.406 0.259 0.198 0.165 0.138 0.237 0.090 0.029 -0.004 0.190 0.043 -0.018 -0.051 -0.078 E. Dividend y ield DVl! DV2! DV3! DV4! DV5! 0.77 0.91 1.08 1.23 1.55 5.51 5.29 5.05 4.84 4.54 0.140 0.172 0.214 0.254 0.341 - 0.029 0.003 0.045 0.085 0.172 -0.076 -0.044 - 0.002 0.038 0.125 1.47 1.20 1.00 0.95 0.92 4.58 5.06 5.13 5.30 5.20 0.321 0.237 0.195 0.179 0.177 0.152 0.068 0.026 0.010 0.008 0.105 0.021 -0.021 - 0.037 - 0.039 1.48 1.19 1.05 0.95 0.90 4.75 5.01 5.03 5.14 5.24 0.311 0.237 0.209 0.185 0.172 0.142 0.068 0.040 0.016 0.003 0.095 0.021 -0.007 -0.031 -0.044 1.04 1.05 6.14 4.87 0.169 0.216 Part 2: Reduced sample D. Market value F. Share price PRl! PR2! PR3! PR4! PR5! G. PE ratio PEl! PE2! PE3! PE4! PE5! H. M arket indices FTA value weighted Equally weighted “Period April 1961 to March 1985, 288 observations. 682 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA M. Levis, Stock market anomalies A survey of the results in part 1 of the table, the full sample, indicates that consistent with other markets, a firm size effect is also evident in the U.K. data. A direct comparison of the relative magnitude of the size effect across other capital markets is difficult because of differing time periods and research design. However, the bulk of the U.S. evidence points to the presence of a higher size premium than the 5.1 per cent per annum (0.42 per cent per month) observed for the LSE.8 The U.K. size effect is also markedly lower than the premium reported by Brown, Kleidon and Marsh (1983) for the Australian market, Berges, McConnell and Schlarbaum (1984) for Canada (about 9 per cent per annum) and Nakamura and Tarada (1984) for the Tokyo Stock Exchange (10.7 per cent per annum). Panel B of the same table confirms the existence of a positive relation between dividend yield and returns. The difference between the two extreme yield portfolios is equal to 10.0 per cent per annum, a premium higher than that reported by Keim (1983) for NYSE firms. The share price ranking procedure in panel C exhibits a pattern of raw average monthly returns remarkably similar to the one found for market size. Estimates of the PE effect are shown in part 2 of the table. For comparative purposes, equivalent estimates for the other three ranking procedures, based on the reduced sample, are presented as well. First, it is worth noting the differences due to the sample size on the portfolio returns reviewed in part 1 of the table. The exclusion of firms with negative earnings, in conjunction with the missing data, resulted in an increase of the monthly returns of the first quintile across all three ranking procedures. Thus, based on the reduced sample, the market size effect reaches a level of 7.7 per cent per anum over the period April 1961 to March 1985, a premium comparable to the 9.5 per cent premium reported by Basu (1983) for NYSE firms. Panel G documents a negative relation between the PE ratio and rates of return. The average PE effect of 7.0 per cent per annum is similar to the effect reported by Basu (1977, 1983) and Reinganum (1981). In short, the monthly average returns of the portfolios based on the four ranking procedures indicate that during the period April 1961 to March 1985, an investment strategy based on dividend yields would have outperformed a PE ratio strategy by 2.40 per cent per annum and a market size and a share price strategy by 1.68 and 2.76 per cent per annum respectively.g ‘A decile instead of a quintile classification augment the size premium markedly. The average monthly return for the smaller size decile is equal to 1.63 per cent per month producing a size premium of 8.6 per cent per annum. Thus in contrast to the U.S. evidence does not appear to be a linear relationship between market size and stock returns across all size portfolios. 9A comparison of these estimates with the equivalent results based on the alternative portfolio construction procedures mentioned in note 3, instantly reveals that the look-ahead bias problem is relevant to the U.K. data as well. While the rates of return for market size and share price portfolios remain essentially unchanged the dividend yield and PE effects could be biased upwards by as much as 2.8 per cent per annum over the period under consideration. M. Lxois, Stock market anomalies 683 Even more interesting, however, are the results shown in column 3 of this table regarding the variability of the portfolios of the various ranking procedures. While the total risk of the five dividend yield, PE and share price portfolios are almost identical, the market size portfolios are strikingly different both to modern portfolio theory and intuition i.e. the higher returns of the smaller portfolios appear to be associated with lower levels of total risk. As a consequence, the mean return per unit of variability of the smaller market size quintile is more than twice the size of its largest counterpart, while the U.K. scaled size premium is 1.8 times higher than its U.S. equivalent. There is little doubt that the low variability of stock returns of the smaller firms’ portfolios is at least partially, attributable to infrequent trading. lo The returns per unit of variability for the PE portfolios exhibit a similar pattern to those found for U.S. data but are consistently about 50 per cent higher than the estimates reported by Basu (1983). Similar conclusions are drawn by comparing the abnormal returns (in terms of total risk) earned by the smallest size portfolio (MVl) for both the equally and value-weighted market indices. It is also interesting to note that while the market value (MV) and share price (PR) portfolios earn similar rates of return, hinting at the possibility of one acting as a proxy for the other, their respective variances are markedly different; in fact, the standard deviation estimates for all five share price portfolios are essentially the same. On this evidence alone it would appear that market size and share price are not perfectly substitutable ranking procedures. This issue is further explored in the following sections. B. Autocorrelation and beta coefficients The first five autocorrelations coefficients for each of the portfolios of the four different ranking procedures, the OLS as well as the AC beta estimates are given in table 2. A significant feature relative to the statistics of U.S. monthly returns is the high-first-order serial correlation ranging from 0.16 to 0.43 for the market value ranking procedure and the significantly higher order correlations observed for the two smaller portfolios. It is also important to note the invariably significant first order serial correlations observed for each of the portfolios by all four ranking procedures. This discrepancy with the U.S. data is consistent with the view that the problem of thin trading is more severe in the British market than in the U.S. In spite of the strong indication of the existence of thin trading the OLS beta estimates are rather surprising: the beta coefficients range from 0.7 for smaller size portfolio to 1.21 for MV5; furthermore, the beta estimates for all “Roll (1981) has shown that infrequent trading causes both covariance and variance terms to be downwards biased, while Dimson and Marsh (1983) reported a correlation coefficient of 0.81 between trading frequency and market capitalisation for the London Stock Exchange. 684 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA M. Levis, Stock market anomalies Table 2 OLS, aggregated beta coefficients and autocorrelations Betas OLS A. M arket MVl MV2 MV3 MV4 MV5 B. rl 0.96 1.02 1.07 1.04 0.92 0.43 0.34 0.29 0.27 0.16 1.01 1.06 1.03 1.01 0.95 1.06 0.98 0.98 1.01 0.99 0.98 1.03 1.04 0.99 1.04 r2 r3 r4 r5 0.25 0.14 0.07 0.03 -0.07 0.24 0.19 0.13 0.09 0.11 0.09 0.01 0.00 0.00 0.00 0.08 - 0.07 -0.10 -0.15 -0.15 0.31 0.26 0.27 0.30 0.30 0.09 -0.01 -0.03 0.07 0.09 0.12 0.15 0.13 0.12 0.17 0.01 0.00 0.01 0.00 -0.01 - 0.05 -0.13 -0.12 - 0.09 -0.11 1.04 1.00 0.99 0.99 0.94 0.30 0.29 0.27 0.28 0.26 0.11 0.05 0.03 0.04 - 0.02 0.13 0.13 0.15 0.15 0.09 - 0.02 -0.12 0.03 0.04 0.02 -0.10 -0.12 -0.11 -0.13 -0.13 1.04 1.02 1.02 1.00 0.94 0.31 0.28 0.28 0.28 0.28 0.16 0.07 0.05 0.02 0.09 0.16 0.15 0.14 0.14 0.12 -0.02 -0.01 0.00 0.02 0.01 -0.07 -0.09 -0.12 -0.11 -0.11 0.13 0.29 -0.09 0.06 0.13 0.14 -0.04 0.00 -0.14 -0.09 value 0.70 0.92 1.06 1.15 1.21 PE ratio PEl PE2 PE3 PE4 PE5 D. Autocorrelations AC Dividend y ield DVl DV2 DV3 DV4 DV5 C. of rates of return.a Share price PRl PR2 PR3 PR4 PR5 0.94 1.02 1.05 1.06 0.99 FTA value weighted index Equally weighted index “OLS and AC betas are estimated using an equally weighted index. The AC beta is estimated using five lagged and one leading market coefficient. portfolios of the three other ranking procedures are essentially equal to unity. It is also worth noticing that the odd disparity between beta estimates would be markedly amplified if a value weighted index was used as the market portfolio. When account of thin trading is taken by using the Aggregated Coefficients method suggested by Dimson (1979), using five lagged and one leading market coefficient, the smaller firms still do not emerge as riskier than their larger counterparts. In fact, our results indicate that all AC beta estimates are not different from unity. This evidence is obviously in sharp contrast with the U.S. findings but not entirely surprising for the U.K. framework. Although no formal tests of the risk-return relationship have been carried out on U.K. data, there is considerable scattered evidence in a number of studies hinting at some marked deviations from the CAPM framework. Dimson’s (1979) tables 7 and 8, for example, show that even when betas are adjusted by the AC method for thin trading, M. Levis, Stock market anomalies 685 smaller firms appear to be associated with lower betas; the betas of the 20 per cent lowest beta estimates do not exceed 0.9, even when more terms are added to the regression. Marsh’s (1979) study of U.K. rights issues concludes that all of the large positive abnormal returns were small companies. Furthermore, Dimson and Marsh (1983) using the Trade-to-Trade method for beta estimation still point to the same paradox, i.e. smaller firms have lower betas than their larger counterparts and the riskiness of smaller firms is not stationary over time. More recently Corhay, Hawawani and Michel (1987) concluded that April ‘is the only month of the year during which the relationship between average portfolios returns and systematic risk is significantly positive on the LSE’ (p. 67). 4. Risk-return relations for the four effects Table 3 presents three different types of abnormal returns using the estimates of models (l), (2) and (3). The results for each one of the ranking procedures, for both the complete and reduced sample, are shown in separate panels. Panel A, for example, shows the abnormal returns based on each of the three risk adjustment models estimates for the five non-randomised market size portfolios and portfolios randomised for dividend yield, share price and PE ratio. A single notation, i.e. MV, DV, PE, and PR refers to non-randomised portfolios; randomised portfolios are labelled with a double code; the smallest market size portfolio, for example, randomised by dividend yield is labelled as zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCB MVl * DV. The second part of the code always refers to the randomisation procedure in operation. The t-values test the hypothesis that the individual portfolio abnormal return is equal to zero, while the Hotelling T2-statistic and the corresponding F-values test the hypothesis that the abnormal return vector for a particular ranking procedure, MVl to MV5 for example, is equal to zero. Consistent with the pattern of beta estimates shown in table 2, risk adjustment models (2) and (3) produce market size premiums markedly higher than model (1) estimates. Thus, the market size effect not only is not eliminated or reduced but is indeed increased when a CAPM risk adjustment is applied. On the other hand, given the beta estimates, it is not surprising that the abnormal returns of the dividend yield, PE and share price portfolios are remarkably robust to the particular type of model employed for risk adjustment purposes. An examination of the non-randomised portfolios across the four panels suggests the presence of significant abnormal returns for all four ranking procedures for both the full and reduced samples. It is apparent from the Fvalues, however, that the size effect is not the most pronounced anomaly on the LSE in comparison to the dividend yield and PE irregularities. The dividend yield ranking procedure, for example, yields a risk-adjusted Table 3 Excess returns, based on three models, for straight and randomised portfolios.” Model (1) zyxwvutsrqponmlkjihgfed Model (3) Model (2) TZ T2 T2 a$) Jv,) up % J) Q,) up G,) W ,) A. Market value MVl 0.452 MV2 0.196 MV3 - 0.084 MV4 -0.200 - 0.296 MV5 3.74 2.94 - 2.03 - 3.58 -2.34 0.11 6.21 0.330 0.163 -0.111 -0.161 -0.182 2.04 1.92 -2.50 -2.18 - 1.08 0.07 4.15 0.253 0.135 -0.061 -0.128 -0.164 1.77 1.91 - 1.40 - 1.86 - 1.21 0.04 2.24 MVl*DV MV2*DV MV3*DV MV4*DV MVS*DV 0.416 0.045 -0.096 -0.173 -0.211 4.17 0.69 - 2.43 -3.40 - 1.90 0.10 5.82 0.333 -0.014 -0.086 -0.148 -0.103 2.45 -0.17 -2.17 -2.15 -0.70 0.08 4.68 0.250 -0.011 - 0.078 -0.090 -0.091 1.90 -0.17 - 1.88 - 1.32 -0.76 0.04 2.20* MVl*PR MV2*PR MV3*PR MV4*PR MVS*PR 0.329 0.158 -0.092 -0.142 -0.225 3.38 2.67 -2.35 -2.65 -2.13 0.08 4.34 0.222 0.110 -0.081 - 0.093 -0.126 1.70 1.51 - 2.05 - 1.32 - 0.94 0.04 2.39 0.153 0.106 - 0.067 - 0.056 -0.112 1.09 1.74 - 1.56 -0.79 -0.97 0.03 1.50* MVl! MV2! MV3! MV4! MV5! 0.607 0.153 - 0.050 -0.190 -0.328 5.65 2.30 - 1.12 -2.83 - 2.45 0.18 10.08 0.508 0.093 - 0.056 -0.133 -0.213 3.28 1.12 - 1.16 - 1.47 - 1.22 0.11 6.00 0.441 0.090 -0.021 - 0.095 -0.197 3.15 1.23 -0.44 - 1.13 -1.41 0.08 4.51 MVl*PE! MVZ*PE! MV3*PE! MV4*PE! MV5*PE! 0.528 0.085 -0.077 -0.083 -0.258 0.17 5.08 0.422 2.89 0.13 2.73 0.11 0.368 9.98 0.024 0.33 7.24 0.025 0.37 6.20 1.41 - 1.71 -0.074 - 1.58 - 0.049 - 1.03 -0.29 - 1.23 -0.027 0.011 0.14 -2.13 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA -0.143 -0.91 -0.134 - 1.04 % B. Dioidend yield DVl DV2 DV3 DV4 DV5 - 0.330 -0.299 -0.058 0.131 0.537 -4.65 -4.99 - 1.40 3.25 7.30 0.24 13.46 -0.341 -0.302 -0.051 0.129 0.547 -4.30 - 3.90 - 1.09 2.92 6.79 0.23 12.86 -0.330 - 0.269 -0.046 0.128 0.498 -4.72 -4.45 -1.12 3.21 6.50 0.20 11.36 DVl*MV DV2*MV DV3*MV DV4*MV DVS*MV -0.346 -0.180 0.001 0.154 0.371 - 5.64 - 4.47 0.03 4.20 6.39 0.19 10.56 -0.357 -0.197 -0.005 0.159 0.400 -5.60 -4.73 -0.14 4.09 6.52 0.19 10.61 -0.338 -0.183 -0.006 0.151 0.377 -5.59 -4.54 -0.18 4.15 6.74 0.19 10.93 DVl*PR DVZ*PR DV3*PR DV4*PR DVS*PR -0.359 - 0.242 -0.065 0.166 0.436 -6.32 -5.69 - 1.77 4.45 7.05 0.24 13.39 -0.368 -0.241 -0.061 0.176 0.440 -6.00 -5.12 - 1.60 4.41 6.82 0.21 11.94 -0.351 -0.220 - 0.058 0.158 0.408 -6.29 -4.91 - 1.61 4.28 6.31 0.20 11.27 DVl! DV2! DV3! DV4! DV5! -0.344 -0.196 0.003 0.166 0.515 - 5.03 -3.36 0.08 3.36 6.55 0.18 10.16 -0.345 -0.182 0.000 0.164 0.520 -4.34 -2.56 0.00 2.98 5.85 0.15 8.31 -0.302 -0.163 0.003 0.154 0.479 -4.18 -2.79 0.08 3.21 5.74 0.13 7.62 DVl*PE! DVZ*PE! DV3*PE! DV4*PE! DVS*PE! -0.215 -0.158 0004 0.094 0.416 - 4.02 -2.96 0.08 2.22 6.10 0.16 9.34 -0.216 -0.148 0.025 0.092 0.400 - 3.62 -2.35 0.52 2.10 5.58 0.14 7.95 -0.183 -0.132 0.021 0.088 0.374 - 3.28 -2.38 0.45 2.12 4.92 0.11 6.32 Table 3 (continued) Model (2) Model (1) zyxwvutsrqponmlkjihg Model (3) T2 % TZ t&J F&J up t&J TZ %J up t(u,) F&J C. PE ratio PEl! PE2! PE3! PE4! PE5! 0.422 0.125 -0.018 -0.141 -0.192 5.55 2.55 -0.42 -2.56 -2.39 0.12 6.98 0.440 0.132 0.005 -0.155 -0.221 5.60 2.52 0.12 -2.41 -2.58 0.12 7.13 0.411 0.121 -0.017 -0.118 -0.176 5.52 2.49 -0.41 -2.15 -2.21 0.12 7.06 PEI*MV! PE2* MV! PE3*MV! PE4* MV! PES*MV! 0.263 0.098 0.007 - 0.065 -0.109 4.40 1.96 0.16 - 1.53 - 1.55 0.07 4.23 0.278 0.118 0.024 - 0.070 -0.151 4.63 2.29 0.55 - 1.56 -2.12 0.08 4.42 0.282 -0.101 0.007 - 0.063 -0.110 4.96 2.02 0.17 - 1.49 - 1.57 0.09 5.25 PEl*DV! PE2*DV! PE3 *DV! PE4*DV! PES*DV! 0.217 0.027 - 0.046 -0.037 -0.016 3.92 0.51 - 1.02 -0.80 -0.26 0.07 4.11 0.213 0.062 -0.031 -0.035 -0.050 3.79 1.18 -0.66 -0.78 -0.79 0.06 3.26 0.210 0.062 - 0.043 - 0.039 -0.015 3.81 1.17 -0.94 -0.88 - 0.24 0.07 3.88 PEi*PR! PE2*PR! PE3*PR! PE4*PR! PES*PR! 0.346 0.079 -0.042 - 0.095 -0.135 5.41 1.47 -0.95 -2.02 -1.82 0.11 6.13 0.350 0.095 - 0.023 -0.103 -0.157 5.33 1.71 -0.50 -2.14 -2.04 0.10 5.93 0.335 0.090 - 0.042 -0.085 -0.123 5.28 1.70 -0.95 -1.85 - 1.68 0.11 6.05 D. Price PRl PR2 PR3 PR4 PR5 0.335 0.136 -0.089 -0.175 -0.177 3.43 2.68 -2.30 -3.53 -2.41 0.08 4.46 0.314 0.125 - 0.078 -0.154 -0.176 2.42 2.19 - 1.81 -2.47 -1.88 0.05 2.59 0.261 0.123 - 0.059 -0.138 -0.162 2.60 2.44 -1.43 -2.72 - 2.25 0.04 2.47 PRl*MV PR2*MV PR3*MV PR4*MV PRS*MV 0.140 -0.011 -0.032 -0.032 -0.023 2.10 -0.25 -0.85 -0.84 - 0.43 0.176 0.024 - 0.037 - 0.033 -0.090 2.47 0.49 -0.93 -0.84 - 1.41 0.05 2.75 0.152 0.026 -0.008 0.038 - 0.098 2.28 0.51 -0.21 0.98 - 1.36 0.04 2.35 PRl*DV PR2*DV PR3*DV PR4*DV PRS*DV 0.278 0.044 -0.132 -0.172 -0.071 3.36 1.02 -3.63 - 3.92 -1.16 0.09 5.33 0.271 0.026 -0.114 -0.174 - 0.049 2.54 0.56 -2.85 -3.56 -0.64 0.07 4.20 0.212 0.048 -0.103 -0.140 - 0.065 2.55 1.10 -2.71 - 3.07 -1.10 0.05 2.96 PRl! PR2! PR3! PR4! PR5! 0.455 0.128 - 0.096 -0.163 -0.172 5.30 2.65 - 2.05 -2.87 - 2.29 0.431 3.94 0.09 0.10 0.13 0.396 4.39 0.120 2.30 5.07 7.32 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA 0.128 2.70 5.62 -0.091 - 1.79 - 0.077 -1.65 -0.133 - 1.90 -0.119 -2.04 -0.153 - 2.07 -0.165 - 1.72 PRl*PE PR2*PE PR3*PE PR4*PE PRS*PE 0.393 0.054 - 0.046 -0.163 - 0.086 4.88 1.11 - 1.10 -3.09 - 1.21 0.11 6.52 2.83 0.356 0.046 -0.041 -0.124 -0.074 3.61 0.96 -0.95 - 1.98 -0.87 0.08 4.36 0.331 0.063 -0.027 -0.124 - 0.067 4.03 1.34 -0.63 -2.38 -0.98 0.08 4.81 “Based on monthly data for the period April 1961 to March 1985. F-values not significant at the 5% levels are noted with a ‘*‘. - Hotelling Ts-statistic Notation: up - abnormal portfolio return T2 F(u,) - F-value for T2-statistic. t(u,) - f-statistic for up 688 M. Levis, Stock market anomalies premium, based on model 1, of 0.83 per cent per month for the full sample, which is almost twice the amount of the 0.42 per cent premium observed for market size effect. Randomising the market size portfolios to account for dividend yield differences has a definite, albeit marginal, impact on the vector of abnormal returns; as portfolios MV2 *DV to MV5 *DV become virtually identical, any remaining indications of a size effect are entirely attributable to the persistent strength of the MVl*DV portfolio. On the other hand, applying a market randomisation to the dividend yield portfolios (DVl*MV to DVS*MV in panel B) has no material impact on either the strength or configuration of the already documented dividend yield effect. The reduced sample estimates in panels A and C provide the evidence for comparing the size versus the PE effects. The F-values for both nonrandomised sets of portfolios indicate abnormal returns significantly different from zero and almost identical premiums. Moreover, controlling the market size portfolios for PE differences or the equivalent PE set for size differences does not alter the essence of these results in any substantive way. On this basis, the results of this study suggest that both effects were present on the LSE for the period under consideration. This conclusion is in line with Cook and Rozeff’s (1984) results but is in contrast to both Basu’s (1983) and Reinganum’s (1981) findings, which support the superiority of either a PE or a size effect respectively. It is also interesting to note that the magnitude of the PE effect is markedly reduced when controlling for dividend yield differences. The appropriate F-value, in panel C - model 1, is reduced from 7.06 to 3.88 while the PE premium, the abnormal return difference between portfolios PEl *DV! and PES*DV!, is reduced to 0.23 per cent per month from the 0.59 per cent equivalent premium present between portfolios PEl! and PE5!. These results provide further support to the emerging overall dominance of the dividend yield effect. With respect to the share price ranking procedure, it is immediately apparent from the relevant non-randomised portfolios in panels A and D that the size and price effects are virtually identical both in terms of premiums and consistency. The noticeable relative prominence evident in the risk-adjusted returns (models 2 and 3) of market size portfolios is entirely due to the uncharacteristic nature of their beta coefficients reported in the previous section. Panel D indicates that the share price effect appears to be resilient to both the market size and dividend yield randomisation procedures; the vectors of abnormal returns of the share price portfolios randomised for market size and dividend yield are still significantly different from zero in spite of the marked reduction of the relevant premiums. This evidence is in direct contrast to the configuration of market size portfolio returns observed in panel A. These results lead one to infer that an investment strategy based on the share price as the sole security selection criterion is better suited for the investor interested in long term consistent M. Levis, Stock market anomalies 689 performance but reluctant to restrict individual holdings to shares that conform to narrow boundaries in terms of market size and dividend yields. In short, the findings presented in this section are consistent with the hypothesis that the dividend yield and PE ratio have a significant impact on the risk-adjusted returns of U.K. firms and are largely independent from each other and other confounding effects. The market size anomaly resembles in many respects the share price effect but ceases to be pervasive when such portfolios are controlled for the differences in dividend yield and share price effects. 5. Interaction between the four effects The evidence in the previous section confirms the presence of a significant dividend yield, PE effects and to a lesser extent a market size and share price effect as well as during the period April 1961 to March 1985. This evidence, however, is not sufficient on its own to indicate whether these effects are homogeneous across each of the particular quintiles of the four ranking procedures. Thus, the issue investigated in this section is to what extent the individual effects depended on the particular quintile of the portfolio formation procedure in operation. If, for example, the dividend yield and the firm size effect are independent of each other, one would expect the abnormal return to be enhanced by adhering to a high dividend yield small size investment strategy. On the other hand, if the two effects are highly interrelated, then an additive return possibility would not exist, since one effect would merely serve-as a proxy for the other. Table 4 presents the abnormal returns using model (1) for all pairs of primary and secondary portfolio groupings. Each of the four panels (A to D) refers to one of the ranking procedures as the primary grouping variable and the other three as the secondary. As the emphasis in this section is on the search for anomalies within the same quintile of the primary ranking variable, only the results based on the full sample are presented (portfolios involve the PE ratio as a primary or secondary variable are based on the estimates derived from the reduced sample). Thus, accurate comparisons of abnormal returns can only be made across the quintiles of the same primary variable and not across quintiles of different primary ranking procedures, since the reduced sample was found to have a material impact on the excess return estimates. Due to space considerations, only the estimates based on model (1) are presented in this paper; given the specific nature of the beta coefficients, discussed in section 3B, estimates of abnormal returns based on models (2) and (3) do not alter the substance of the results presented in this secti0n.l 1 “Detailed results based on models (2) and (3) are available from the author on request Table 4 Excess returns of various combination portfolios based on model (1) UP r(u,) Share price PE ratio Dividend yield T2 TZ TZ F(u,) F(u,) zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIH F&J zyxwvutsrqponmlkjihgfedcbaZY %J tw A. Market value as prwnary group MVl 1 0.011 0.04 0.14 2 - 0.242 -1.36 8.14 3 0.136 0.87 4 0.446 2.62 5 0.884 4.87 4.40 2.38 2.85 1.33 1.41 0.839 0.406 0.480 0.208 0.272 0.08 4.38 0.564 0.328 0.168 0.202 0.002 2.50 1.85 0.99 1.19 0.01 0.03 1.96* MV2 1 2 3 4 5 - 0.474 0.020 0.235 0.303 0.505 -3.58 0.19 2.40 3.14 3.97 0.15 8.29 3.01 0.339 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPO 0.04 0.02 0.211 1.52 2.34 1.59 0.186 1.17* 0.215 1.91 -0.016 -0.14 0.148 1.51 0.72 0.079 0.048 0.46 -0.95 -0.136 0.053 0.40 MV3 1 2 3 4 5 -0.398 - 0.277 -0.036 0.095 0.274 -3.67 -3.10 -0.47 1.10 2.74 0.09 5.39 0.150 0.125 - 0.008 - 0.202 -0.170 1.44 1.37 - 0.09 -2.11 -1.52 0.04 2.06* 0.010 - 0.060 - 0.026 - 0.057 -0.172 0.09 -0.57 -0.21 -0.70 -1.72 0.02 0.89* MV4 1 2 3 4 5 - 0.399 -0.211 -0.157 -0.036 0.151 -3.36 -2.08 - 1.75 -038 1.50 0.06 3.17 0.038 -0.004 -0.155 -0.163 -0.192 0.32 -0.04 - 1.42 - 1.46 - 1.28 0.02 0.91* 0.033 -0.190 -0.195 -0.151 -0.138 - 0.29 1.73 1.91 1.67 1.53 0.03 1.52* 1 2 3 4 5 - -2.60 - 1.36 - 1.35 -0.38 0.49 0.05 2.67 0.047 -0.210 -0.265 -0.239 -0.322 - 0.30 1.39 1.72 1.56 1.70 0.04 2.34* - 0.056 -0.163 -0.134 -0.234 -0.235 -0.36 - 1.04 -0.89 - 1.72 - 1.57 0.02 1.17* MV5 0.432 0.206 0.209 0.053 0.068 PE ratio Market value B. Ditlldend yield as primary Share price group DVl 1 2 3 4 0.023 - 0.426 - 0.424 - 0.432 -0.389 0.09 -2.50 -3.31 - 3.30 -2.32 0.10 6.02 - 0.037 -0.319 -0.353 -0.374 - 0.426 -0.33 -3.12 - 3.09 -2.98 - 2.88 0.06 3.73 0.086 -0.340 -0.306 -0.587 - 0.475 004 -2.03 -2.61 -5.61 -3.82 0.16 8.97 DV2 1 2 3 4 5 -0.114 - 0.370 -0.369 -0.170 -0.325 -0.90 -4.34 -3.81 - 1.28 - 1.90 0.14 7.76 -0.009 -0.173 -0.219 -0.218 -0.194 -0.98 - 1.93 -2.24 - 2.08 - 1.42 0.03 1.84* -0.219 -0.261 -0.361 -0.241 -0.265 - 2.24 - 2.79 -3.55 - 2.24 -2.53 0.09 4.92 DV3 1 2 3 4 5 0.198 -0.131 -0.034 -0.106 -0.156 1.46 -1.47 - 0.45 -1.03 - 1.07 0.02 1.29* 0.030 0.002 0.001 - 0.084 0.069 0.31 0.02 0.01 -0.92 0.69 0.01 0.35* 1 2 0.290 0.263 0.054 - 0.044 0.075 1.86 2.73 0.70 -0.47 0.61 0.06 3.31 0.333 0.245 0.057 0.082 0.054 3.06 2.53 0.69 0.95 0.50 0.853 0.606 0.384 0.303 0.341 4.56 4.67 3.13 3.08 3.08 0.20 11.50 0.722 0.555 0.299 0.399 0.419 4.25 4.25 2.33 3.38 3.06 DV4 4 5 DVS 1 2 4 0.013 0.12 0.000 0.00 0.02 1.11* zyxwvutsrqponm -0.163 -0.128 -0.061 - 2.05 - 1.56 -0.74 0.05 3.08 0.340 0.252 -0.096 0.039 0.112 2.90 2.75 - 1.25 0.52 1.52 0.09 5.04 0.14 7.64 0.839 0.587 0.411 0.216 0.363 5.54 5.36 3.99 2.27 3.83 0.17 9.48 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQP 691 M. Levis, Stock market anomalies Table 4 (continued) Market value % tw Share price Dividend yield TZ T2 T2 Fb,) up t&J &$I up . t&J %J 0.182 0.174 0.392 0.419 0.842 1.69 1.70 3.56 3.41 5.68 0.13 7.40 0.912 0.43 1 0.422 0.099 0.182 5.59 3.38 3.83 0.99 1.76 0.14 8.21 0.265 0.161 0.036 0.001 0.076 2.04 1.54 0.38 0.01 0.89 0.03 1.53* C. PE ratio as pnmary group PEl 1 2 3 4 5 0.901 0.476 0.243 0.262 0.173 4.41 3.42 2.10 2.29 1.30 0.13 7.44 PE2 1 2 3 4 5 0.158 0.145 0.128 0.163 0.011 0.92 1.26 1.26 1.52 0.07 0.03 1.42* -0.178 0.062 0.159 0.220 0.323 - 1.90 0.65 1.82 2.28 2.57 0.06 3.12 PE3 1 2 3 4 5 0.413 -0.109 -0.127 -0.083 -0.182 2.78 -1.00 - 1.37 -0.73 -1.23 0.05 2.97 -0.232 -0.185 - 0.046 -0.041 0.235 -2.30 - 2.05 -0.50 -0.51 2.01 0.04 2.05* 0.189 0.040 -0.125 -0.233 -0.103 1.54 0.41 -1.44 - 2.53 - 1.01 0.03 1.74* PE4 1 2 3 4 5 0.254 -0.109 - 0.305 -0.109 -0.322 1.43 -1.10 -3.06 -0.82 -1.98 0.06 3.19 -0.345 -0.316 - 0.096 -0.075 0.310 - 3.20 -2.89 -0.89 -0.89 2.32 0.06 3.30 0.289 - 0.079 - 0.299 - 0.247 -0.224 2.16 -0.85 - 3.22 -2.21 - 1.93 0.05 2.85 PE5 1 2 3 4 5 0.112 - 0.278 -0.185 -0.178 - 0.349 0.62 -2.30 -1.58 - 1.14 - 1.92 0.04 2.35 -0.344 -0.397 -0.303 -0.081 0.163 -2.58 - 3.02 - 2.38 -0.69 1.44 0.04 2.57 0.002 - 0.236 -0.170 - 0.242 - 0.269 0.01 -2.06 - 1.37 - 1.88 -2.21 0.03 1.43* PR2 1 2 3 4 5 0.193 0.238 0.178 0.020 - 0.014 1.10 2.07 1.76 0.19 -0.11 PE ratio Dividend yield Market value D. Share price as primary group 2.71 0.05 PRl 1 0.693 2.39 2.87 2 0.394 -0.08 3 -0.012 1.34 4 0.174 0.41 5 0.054 0.03 1.48* 0.057 -0.292 -0.001 0.562 0.834 0.26 - 1.88 -0.01 4.73 5.86 0.16 11.17 0.760 0.522 0.383 0.189 0.124 4.79 3.53 3.05 1.51 0.74 -0.378 0.035 0.114 0.235 0.498 -3.10 0.43 1.31 2.49 4.48 0.12 6.80 0.441 0.172 0.014 0.083 -0.068 3.71 1.73 0.13 0.89 -0.65 0.11 6.21 o.Ot5 3.29 M. Levis, Stock market anomalies 692 Table Market 4 (continued) Dividend value yield PE ratio TZ %J UP F(u,) zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA as pmary group D. Share pee PR3 1 2 3 4 5 -0.086 0.111 -0.130 -0.151 - 0.040 -0.60 1.27 - 1.34 -1.38 -0.26 0.03 1.79* -0.349 -0.187 - 0.068 0.035 0.194 -3.69 -2.12 -0.93 0.44 2.21 0.06 3.24 0.117 - 0.053 -0.160 -0.143 -0.144 1.16 -0.54 - 1.80 - 1.56 -1.13 0.02 1.27* PR4 1 2 3 4 5 -0.011 -0.019 -0.290 -0.129 - 0.243 -0.07 -0.22 -3.23 - 1.09 - 1.47 0.05 2.69 -0.581 - 0.274 -0.177 -0.003 0.275 -5.34 -2.88 - 2.09 -0.04 3.30 0.12 6.92 0.300 -0.179 -0.261 -0.210 - 0.246 3.06 - 1.99 - 2.70 -2.18 - 1.75 0.08 4.54 PR5 1 2 3 4 5 - 0.020 -0.195 -0.081 -0.193 -0.320 -0.15 -2.13 -0.85 - 1.45 - 1.84 0.03 1.86* -0.505 -0.382 -0.160 - 0.040 0.238 -4.03 -3.34 - 1.65 -0.50 2.97 0.10 5.91 0.058 -0.011 -0.185 -0.346 -0.280 0.60 -0.12 - 1.72 -2.98 - 2.23 0.04 2.45 “Based on monthly data for the period the 5”/ levels are noted with a ‘*‘. portfolid-return Notation: ug - abnormal t(u,) - t-statistic for up April 1961 to March T2 F(u,) 1985. F-values not significant at zyxwvutsrqponmlkjihgfedcba - Hotelling T2-statistic - F-value for T2-statistic. The findings of the previous section indicated that the size and PE effects appear to work independently from each other. Closer investigation of the evidence in panels A and C, however, reveals that the aggregate results in table 3 obscure some of the subtleties involved in the interaction between market size and PE effects. Examination of the five market size portfolios in panel A indicates that the PE effect is firmly established within the smallest market size portfolio. The F-values for all other PE portfolios are not significant or very marginally so at the 5 per cent level. Panel C points to a very similar picture with regard to the nature of the size effect, i.e. the size effect is mainly concentrated within the smallest PE quintile; within higher PE portfolios its presence is at best marginal. Thus, it appears that there is some degree of interaction between market size and PE predominantly within the lowest quintiles of the two ranking procedures. The relation between market size and dividend yield effects is rather more complicated. A comparison with the estimates in table 3, panel A, confirms that a combination of small size and high dividend yield generates portfolios earning consistently higher abnormal returns than the equivalent aggregate market size portfolios. The F-values in table 4, panel A, point to the presence of a dividend yield effect at each level of market size; this effect, however, gradually declines as one moves from portfolio MVl to MV5 but remains M. Levis, Stock market anomalies 693 significant at the 5 per cent level. Moreover, the dividend yield premium (the difference between the smallest and largest dividend yield quintile within each market size portfolio in panel A of the same table) is never lower than 0.5 per cent per month and increases gradually from dividend yield quintile 1 to 5. This evidence, in conjunction with the results of the previous section, leave little doubt about the pervasive nature and persistence of the dividend yield effect. On the other hand, closer investigation of the results in panel B casts further doubts on the eficacy of the size effect. First, observe the inconsistent pattern of F-values across the five dividend yield portfolios; the size effect appears not to be entirely independent of the level of dividend yield; its presence is clearly firmer within the highest dividend yield quintile. Second, the pattern of abnormal returns for size portfolios within quintiles DVl to DV3 does not provide unambiguous evidence in support of a size effect since there is very little to distinguish between the abnormal returns of market size portfolios 2 to 4. Keim (1985) conjectured that the excess return of dividend yield portfolios reflects the contents of these portfolios in terms of market size firms, i.e. a large proportion of smaller firms are concentrated in the high dividend yield categories. To further investigate the validity of this conjecture for U.K. data, the average dividend yield of each market size quintile was computed as well as the composition of these portfolios in terms of dividend yields. The analysis supports Keim’s hypothesis. The mean dividend yield of the smaller portfolio is 8.0 per cent in contrast to the 4.6 per cent dividend yield of its larger counterpart. Furthermore, the smaller market size portfolios contained a disproportionately larger proportion of high dividend yield firms, while a high concentration of low to medium yield stocks was evident in larger size portfolios. I2 Although the emerging picture is remarkably similar to the U.S. evidence, i.e. high concentration of smaller (larger) firms within the higher (lower) dividend yield groups, on balance the weight of evidence does not support the notion that the dividend yield is simply a surrogate for market size. A direct comparison between the dividend yield and PE effects in table 3 shows that both effects are at work independently. Controlling one for the confounding effects of the other does not alter the essence of the observed irregularities. At the same time, it is also clear that the PE effect is markedly reduced when full account is taken of the differences in dividend yields across the five PE portfolios. The results in table 4, panels B and C, confirm this conclusion. Observe, for example, the PE premiums across each of the five dividend yield portfolios; the largest such premium is evident within the lowest dividend yield quintile, namely 0.39 per cent per month. Panel C, however, indicates the dividend yield effect produces premiums consistently superior. The largest premium for quintile PEl was 0.66 per cent while the “For further details on average dividend yields and portfolio composition see Levis (1987). 694 M. Levis. Stock market anomalies lowest, quintile PE3, was 0.47 per cent per month. Thus, there is little doubt that these effects are to a certain extent interrelated, but the dividend yield can be still be confidently regarded as the dominant one. A survey of panels A to D confirms the overall striking resemblance between the size and price effects mentioned in the previous section. Both exhibit very similar premiums and F-values across the four panels. Moreover, a direct comparison between the two provides further support for the notion that there is a strong relationship between the two. The price effect, for example, is virtually non-existent within individual market size portfolios. On the other hand, the presence of a size effect is apparent within the lowest price quintile only. Further support for this interaction between market size and share price can also be obtained from an analysis of the mean share price of each market size quintile and the share price composition of these quintiles. The average share price of the firms included in the smaller market size portfolio was equal to 51 pence (in 1984 prices) while that of the largest was four times higher. Furthermore, about 57 per cent of the population of firms included in the smaller size portfolio were firms belonging to the lowest share price quintile. On the other hand, 46 per cent of those in the larger market size group were also members of the highest share price group. 6. Conclusions The empirical evidence reported in this paper indicates that at least during the April 1961 to March 1985 time period the LSE exhibited a number of irregularities in stock price behaviour. The well documented size effect appears to be only one of them. Investment strategies based on dividend yields, PE multiples and share prices seem to be at least as profitable, if not more, as strategies based on market size. Furthermore, the size effect is not entirely independent of the other three portfolio formation procedures. The significant market size effect, for example, is markedly reduced when control over the differences in dividend yield is exercised. Any further size effects are attributed entirely to the uncharacteristic nature of beta coefficients observed for smaller size portfolios. The implied risk-return relation is not altered even when a Dimson type beta estimate is applied. Closer examination reveals that the market size effect is not consistent across all dividend yields, PE or share price quintiles. It is also worth noting that from the configuration of abnormal returns across the various portfolio formation procedures it is often hard to distinguish between the size and share price effects. This evidence lends further credence to the view that these two variables are either proxies for each other or both are just proxies for more fundamental determinants of expected returns for common stocks. The dividend yield or the PE multiple for example, appear as possible candidates for such a proxy. Their individual effects are still maintained even when control for their M. Levis, Stock market anomalies 695 reciprocal differences is exercised, in spite of the fact that neither one is consistent at every single level of the other. In short, the weight of the evidence presented in this paper raises questions about the strength of firm size as an independent determinant of the stock returns generating process. Its strong dependence with the other firm attributes suggest that it cannot be viewed as either an independent anomaly or as a profitable investment strategy in its own right. In that sense, the results also have implications for various types of event studies. If one is to control for factors other than risk, then the dividend yield and PE multiple differences might be more appropriate factors. Such adjustments are particularly important for the LSE in view of the fact that the direction of the riskreturn relation is still rather ambiguous. References Ball, R., 1978, Anomalies in relationships between securities’ yields and yield-surrogates, Journal of Financial Economics 6, June, 103-126. Banz, R.W., 1981, The relationship between return and market value of common stocks, Journal of Financial Economics 9, March, 3-18. Banz, R.W. and W.J. Breen, 1986, Sample dependent results using accounting and market data: Some evidence, Journal of Finance 41, Sept., 779-794. Basu, S., 1977, Investment performance of common stocks in relation to their price-earnings ratios: A test of the efficient market hypothesis, Journal of Finance 32, June, 663-682. Basu, S., 1983, The relationship between earnings’ yields, market value and the returns for NYSE stocks: Further evidence, Journal of Financial Economics 12, June, 129-156. Berges, A., J.J. McConnell and G.G. Schlarbaum, 1984, The turn-of-the-year in Canada, Journal of Finance 39, Mar., 185-192. Blume, M., 1980, Stock returns and dividend yields: Some more evidence, Review of Economics and Statistics 62, Nov., 567-577. Blume, M. and F. Husic, 1973, Price, beta and exchange listing, Journal of Finance 28, May, 283-299. Blume, M. and R. Stambaugh, 1983, Biases in computed returns: An application to the size effect, Journal of Financial Economics 12, Nov., 387404. Brown, P., A. Kleidon and T. Marsh, 1983, New evidence on the nature of size-related anomalies in stock prices, Journal of Financial Economics 12, June, 33-56. Cook, J. and M.S. Rozeff, 1984, Size and earnings/price ratio anomalies: One effect or two?, Journal of Financial and Quantitative Analysis 19; Dec., 449-466. Corhav, A., G. Hawawini and P. Michel. 1987. Seasonalitv in the risk-return relationshin: Some international evidence, Journal of Finance 42, Mar., 49168. Dimson, E., 1979, Risk measurement when shares are subject to infrequent trading, Journal of Financial Economics 7, June, 197-226. Dimson, E. and P. Marsh, 1983, The stability of U.K. risk measures and the problem of thin trading, Journal of Finance 38, June, 753-783. Dimson, E. and P. Marsh, 1986, Event study methodologies and the size effect: The case of U.K. press recommendations, Journal of Financral Economics 17, 113-143. Elton, E., M. Gruber and J. Rentzler, 1983, A simple examination of the empirical relationship between dividend yields and deviations from the CAPM, Journal of Banking and Finance 7, Mar., 135-146. Gordon, R.H. and D.F. Bradford, 1980, Taxation and the stock market valuation on capital gains and dividends: Theory and empirical results, Journal of Public economics 14, 109136. 696 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA M. Levis, Stock market anomalies Gultekin, M.F. and N.B. Gultekin, 1983, Stock market seasonality: International evidence, Journal of Financial Economics 12, Dec., 469482. Goodman, D.A., J.W. Peavy and E.L. Cox, 1986, The interaction of firm size and price-earnings ratio on portfolio performance, Financial Analyst Journal, Jan.-Feb., 9-12. Jatfe, J., D. Keim and R. Westerlield, 1988, Earnings yields, market values and stock returns, Paper presented at the NATO Advanced Research Workshop, Portugal, Apr. Keim, D., 1983, Size related anomalies and stock return seasonality: Further empirical evidence, Journal of Financial Economics 12, June, 13-32. Keim, D., 1985, Dividend yields and stock returns, Journal of Financial Economics 14, 473-489. Levis, M., 1985, Are small firms big performers?, The Investment Analyst 76, Apr., 21-26. Levis, M., 1987,. An exploratory investigation into the small size effect, Manuscript (University of Bath, Bath). Marsh, P., 1979, Equity rights issues and the efficiency of the U.K. stock market, Journal of Finance 34, Sept., 839-862. Litzenberger, R.H. and K. Ramaswamy, 1979, The effect of personal taxes and dividends on capital asset prices: Theory and empirical evidence, Journal of Financial Economics 7, June, 163-195. Miller, M. and M. Scholes, 1982, Dividend and taxes: Some empirical evidence, Journal of Political Economy 90, 1118-l 141. Nakamura, T. and N. Tarada, 1984, The size effect and seasonality in Japanese stock returns, Manuscript (Nomura Research Institute). Peavy, J.W. and D.A. Goodman, 1983, Industry-relative price-earnings ratios as indicators of investment returns, Financial Analyst Journal, Jul.-Aug., 6&65. Reinganum, M., 1981, Misspecification of capital asset pricing: Empirical anomalies based on earnings’ yields and market values, Journal of Financial Economics 9, Mar., 19-46. Reinganum, M., 1983, The anomalous stock market behavior of small firms in January. Empirical tests for tax-loss selling effects, Journal of Financial Economics 12, June, 89-104. Roll, R., 1981, A possible explanation of the small firm effect, Journal of Finance 36, Sept., 879-888. Smithers, J., 1986, London share price data base (London Business School, London). Stoll, H.R. and R.E. Whaley, 1983, Transaction costs and the small firm effects, Journal of Financial Economics 12, 57-78.