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Does Quality Matter?

Jalrup, Lovisa LU and Patel, Sawan LU (2020) NEKN02 20201
Department of Economics
Abstract
The purpose of this study is to investigate if there is any size effect in the Swedish stock market between April 2010 and December 2019, and if controlling for firms' quality improves the performance of a size-based investment strategy. The risk premium of firms with smaller market value of equity has since its discovery been under heavy scrutiny. Recent studies suggest that by quality-control, the size-based investment strategy can be improved. It is therefore highly relevant for the investor to understand how quality affects such a strategy. By employing a double sorting portfolio construction by size and quality as well as a cross-sectional regression using the Fama-MacBeth two-step regression, we examine if a small-minus-big portfolio... (More)
The purpose of this study is to investigate if there is any size effect in the Swedish stock market between April 2010 and December 2019, and if controlling for firms' quality improves the performance of a size-based investment strategy. The risk premium of firms with smaller market value of equity has since its discovery been under heavy scrutiny. Recent studies suggest that by quality-control, the size-based investment strategy can be improved. It is therefore highly relevant for the investor to understand how quality affects such a strategy. By employing a double sorting portfolio construction by size and quality as well as a cross-sectional regression using the Fama-MacBeth two-step regression, we examine if a small-minus-big portfolio yields a positive excess return and the interaction of quality and the size risk factor. We find that there is no size effect without any quality-control, in the Swedish stock market. However, in conjunction with the quality metrics, size is a relevant risk factor in asset pricing. In conclusion, by constructing the portfolio of high-quality firms, in terms of the Return on Assets or the credit rating of a Merton-based Credit Risk Model, the size-based investment strategy can be improved. (Less)
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author
Jalrup, Lovisa LU and Patel, Sawan LU
supervisor
organization
course
NEKN02 20201
year
type
H1 - Master's Degree (One Year)
subject
keywords
Investment strategy, Small-Minus-Big (SMB), size effect, firm quality, Fama-MacBeth two-step regressions.
language
English
id
9013283
date added to LUP
2020-08-29 11:17:28
date last changed
2020-08-29 11:17:28
@misc{9013283,
  abstract     = {The purpose of this study is to investigate if there is any size effect in the Swedish stock market between April 2010 and December 2019, and if controlling for firms' quality improves the performance of a size-based investment strategy. The risk premium of firms with smaller market value of equity has since its discovery been under heavy scrutiny. Recent studies suggest that by quality-control, the size-based investment strategy can be improved. It is therefore highly relevant for the investor to understand how quality affects such a strategy. By employing a double sorting portfolio construction by size and quality as well as a cross-sectional regression using the Fama-MacBeth two-step regression, we examine if a small-minus-big portfolio yields a positive excess return and the interaction of quality and the size risk factor. We find that there is no size effect without any quality-control, in the Swedish stock market. However, in conjunction with the quality metrics, size is a relevant risk factor in asset pricing. In conclusion, by constructing the portfolio of high-quality firms, in terms of the Return on Assets or the credit rating of a Merton-based Credit Risk Model, the size-based investment strategy can be improved.},
  author       = {Jalrup, Lovisa and Patel, Sawan},
  keyword      = {Investment strategy,Small-Minus-Big (SMB),size effect,firm quality,Fama-MacBeth two-step regressions.},
  language     = {eng},
  note         = {Student Paper},
  title        = {Does Quality Matter?},
  year         = {2020},
}