Size Premium Waves
Small firms earned higher average returns than big firms over the past century. However, the relation between firm size and expected returns has varied significantly over time. The size premium was large and significant before 1970, disappeared in following two decades, and reemerged strongly after 2000. The periods with a significant size effect are preceded by persistently higher microeconomic uncertainty, measured as the cross-sectional dispersion in firm productivity. We explain the size premium waves in an investment-based asset pricing model featuring time-varying microeconomic uncertainty. Small firms are more exposed to macroeconomic risks relative to big firms, and this relation is magnified during states of high productivity dispersion. The model generates a positive unconditional size premium, but can reproduce a statistically insignificant (significant) size premium in periods of low (high) micro uncertainty.