SMALL FIRM MUTUAL FUNDS - ADDITIONAL EVIDENCE ON THE SMALL FIRM EFFECT

Returns generated with small firm mutual fund data are used to examine the extent to which identification of a "small firm effect" is due to the difficulty in measuring the direct and indirect transaction costs involved in investing in the common shares of small capitalization stocks. Little if any evidence of the excess risk-adjusted returns is obtained for either of the period 1978-1983, when the small firm effect was observed, or the period 1984-1989, when it was not. The 'small firm effect" may therefore be attributed to (1) higher direct transaction costs including bid-ask spread and broker fees and (2) higher indirect transaction costs including portfolio management expenses and market impact costs.