JBAFP 2020, 2(1), 6; doi: 10.35995/jbafp2010006
The Cyclical Behaviour of the Small-Cap Premium: A Regime-Switching Approach
Received: 27 Aug 2019 / Revised: 12 Feb 2020 / Accepted: 2020-02-12 / Published: 2020-02-14
While the average annual small-cap premia for the US and Canada are substantial over long horizons, there is considerable time variation of this premium within and across these countries. For the US, during expansions, the average annualized premium is a sizable 5.44%, while during recessions, there is a small-cap discount of 6.23%. The differentials are less pronounced in Canada. This paper investigates the hypothesis that the variation of the small-cap premium is related to macroeconomic and financial variables that can be captured by a nonlinear time series econometric model, i.e., the smooth transition autoregressive model (STAR model), with different factor sets across regimes between and countries. The regimes reflect expansionary vs. contractionary phases of the business cycle. For the Canadian small-cap premium, an augmented factor model that includes US factors dominates a purely domestic factor model, which is consistent with integrated markets.
Keywords: small-cap premium; business cycles; nonlinear modelling
This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. (CC BY 4.0).
Switzer, L.N.; Picard, A. The Cyclical Behaviour of the Small-Cap Premium: A Regime-Switching Approach. JBAFP 2020, 2, 6.
Switzer LN, Picard A. The Cyclical Behaviour of the Small-Cap Premium: A Regime-Switching Approach. Journal of Business Accounting and Finance Perspectives. 2020; 2(1):6.
Switzer, Lorne N.; Picard, Alan. 2020. "The Cyclical Behaviour of the Small-Cap Premium: A Regime-Switching Approach." JBAFP 2, no. 1: 6.