Studies of the small-firm effect indicate that there may be superior return potential in investing in smaller-capitalization firms, because:
A)the high P/E ratios of many of these firms eventually lead to superior returns.
B)smaller firms have fewer expenses, therefore, making more money for their investors.
C)there is less efficiency in this segment of the market, due to minimal institutional participation.
D)smaller firms are always growing, along with the returns that their investors receive.

Question

Quizplus · Accepted Answer

Studies have shown that the small-firm effect mainly stems from the inefficiency of the market segment in which smaller firms operate. Compared to larger companies, smaller-cap firms tend to have less analyst coverage and fewer institutional investors, making their share prices more susceptible to price distortions caused by information asymmetries. This means that there are greater opportunities for investors to find undervalued stocks and profit from them. However, it is important to note that investing in smaller-cap firms carries higher risk due to their limited resources and potential for greater volatility.

Studies of the Small-Firm Effect Indicate That There May Be