Marc R. Reinganum, A New Empirical Perspective on the CAPM, The Journal of Financial and Quantitative Analysis, Vol. 16, No. 4, Proceedings of 16th Annual Conference of the Western Finance Association, June 18-20, 1981, Jackson Hole, Wyoming (Nov., 1981), pp. 439-462

This research investigates the influence of market microstructure on liquidity premiums. Premiums of a competitive, multiple-dealership market (NASDAQ) are contrasted with those of a monopolistic, specialist system (NYSE). Differences in liquidity premiums are estimated from monthly stock returns. For small firms, the average returns of NYSE securities exceed the average returns of NASDAQ securities. This return differential persists after controlling for size, risk, and liquidity-related variables. Neither the NYSE nor NASDAQ dominates the other in providing liquidity. The NASDAQ appears to have a liquidity advantage over the NYSE for small firms but not for large companies.

Small firms experience large returns in January and exceptionally large returns during the first few trading days of January. The empirical tests indicate that the abnormally high returns witnessed at the very beginning of January appear to be consistent with tax-loss selling. However, tax-loss selling cannot explain the entire January seasonal effect. The small firms least likely to be sold for tax reasons (prior year ‘winners’) also exhibit large average January returns, although not unusually large returns during the first few days of January.

This study documents empirical anomalies which suggest that either the simple one-period capital asset pricing model (CAPM) is misspecified or that capital markets are inefficient. In particular, portfolios based on firm size or earnings/price (E/P) ratios experience average returns systematically different from those predicted by the CAPM. Furthermore, the ‘abnormal’ returns persist for at least two years. This persistence reduces the likelihood that these results are being generated by a market inefficiency. Rather, the evidence seems to indicate that the equilibrium pricing model is misspecified. However, the data also reveals that an E/P effect does not emerge after returns are controlled for the firm size effect; the firm size effect largely subsumes the E/P effect. Thus, while the E/P anomaly and value anomaly exist when each variable is considered separately, the two anomalies seem to be related to the same set of missing factors, and these factors appear to be more closely associated with firm size than E/P ratios.

Empirical research indicates that small firms earn higher average rates of return than large firms, even after accounting for beta risk. Roll conjectured that the small firm effect might be attributed to improper estimation of security betas. The evidence shows that while the direction of the bias in beta estimation is consistent with Roll's conjecture, the magnitude of the bias appears to be too small to explain the firm size effect.

This paper empirically investigates the seasonal behavior of the liquidity premium in asset pricing. The evidence suggests a strong seasonal component. In the 1961–1990 period, the liquidity premium is reliably positive only during the month of January. For the non-January months, one cannot detect a positive liquidity premium. The impact of the relative bid-ask spreads on asset pricing in non-January months cannot be reliably distinguished from zero. In contrast to Amihud and Mendelson (1986), however, our evidence suggests that the size effect is significant, even after controlling for spreads.