Assessing Risk in Turnover-Based Equity Size Strategies

Summary

The document evaluates the equity size effect using dollar turnover rather than market capitalization. It reports that a beta-neutralized and low-volatility-neutralized Cold-Minus-Hot portfolio remains significant over the long term, with a t-statistic of 5.1. Compared with the conventional market-cap-based SMB factor, these portfolios are described as less negatively correlated with the low-volatility anomaly.

The risk analysis emphasizes that size portfolios are nearly unskewed overall and that extreme risk is concentrated in the large-cap leg; small-cap stocks are reported to have positive skewness. At the individual-stock level, small-cap, low-turnover stocks show more frequent extreme drawdowns even after volatility adjustment. The document characterizes this idiosyncratic risk as diversifiable, complicating a simple risk-premium explanation. It does not provide portfolio construction details, sample period, transaction costs, or robustness tests, so the reported significance and risk comparisons cannot by themselves establish investable performance.

Key ideas

• The size effect is measured using dollar turnover and a Cold-Minus-Hot portfolio construction.
• The reported long-term t-statistic is 5.1 after beta and low-volatility neutralization.
• Turnover-based size portfolios are less negatively correlated with low volatility than market-cap SMB.
• Extreme portfolio risk is reported to be concentrated in the large-cap leg.
• Small-cap, low-turnover stocks have more frequent volatility-adjusted drawdowns, but the document describes this idiosyncratic risk as diversifiable.

Tags

# The "Size Premium" in Equity Markets: Where is the Risk?


# The "Size Premium" in Equity Markets: Where is the Risk?









We find that when measured in terms of dollar-turnover, and once $β$-neutralised and Low-Vol neutralised, the Size Effect is alive and well. With a long term t-stat of $5.1$, the "Cold-Minus-Hot" (CMH) anomaly is certainly not less significant than other well-known factors such as Value or Quality. As compared to market-cap based SMB, CMH portfolios are much less anti-correlated to the Low-Vol anomaly. In contrast with standard risk premia, size-based portfolios are found to be virtually unskewed. In fact, the extreme risk of these portfolios is dominated by the large cap leg; small caps actually have a positive (rather than negative) skewness. The only argument that favours a risk premium interpretation at the individual stock level is that the extreme drawdowns are more frequent for small cap/turnover stocks, even after accounting for volatility. This idiosyncratic risk is however clearly diversifiable.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.