BItNotes n°8

BItNotes n°8
 
"Are euro area small caps an asset class? Evidence from mean-variance spanning tests"
G.Petrella - May 2003

This paper investigates whether euro area small capitalization stocks are an asset class, i.e., if investing in this category of stocks enhances portfolio's mean-variance characteristics. We perform regression-based tests for mean-variance spanning in order to detect the effect of euro area small caps on the minimum variance frontier, and apply different measures to assess the extent of diversification gains. Empirical analysis shows that euro area small and mid cap stocks, as classified by size quartile and quintile rankings, arise as truly autonomous asset classes. This result is robust to different methodologies used to form size-based portfolios, and holds relative to both euro area large cap stocks and other international asset classes, US small capitalization stocks included. We also investigate the source of the rejection of the spanning hypothesis. We find that both the tangency portfolio and the global minimum variance portfolio can be improved by the inclusion of euro area small and mid cap stocks. The evidence is stronger in favour of the enhancement of the tangency portfolio. This result is particularly important for investors with low risk aversion, as they would benefit more from the enlargement of the minimum variance frontier.

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For further information please send an e-mail to:
giovanni.petrella@unicatt.it