Understanding the Stable Components of Seasonality in the Size Effect

This paper employs a sequential portfolio sorting procedure, called DSN, to factor size characteristics into returns. This leads to narrower portfolios than the original Fama-French (FF) ‘small’ and ‘big’ SMB components. The DSN sorting uncovers a purely seasonal part of the global size premium, due to a January effect. The stocks that are common to the FF and DSN small cap portfolios are smaller and of lower quality than those that are only retained by the FF procedure. This phenomenon supports a “tax-loss-pruning” hypothesis, in which investors discard small cap stocks with the lowest quality around the year end for tax reasons.