Davids, Goliaths, and Business Cycles

Abstract

We show that a simple, intuitive variable, Goliath versus David (GVD), reflects time variation in discount rates related to changes in aggregate business conditions. GVD is the annual change in the weight of the largest 250 firms in the aggregate stock market and is motivated by research that shows that small firms are more severely impacted than large firms by economic shocks due to differences in access to external finance. We find that GVD is the best single predictor of out-of-sample market returns among traditional predictors, predicting quarterly market returns with an out-of-sampleR2of 6.3% in the 1976–2011 evaluation period.

Firm size, economic risks, and the cross-section of international stock returns

“…2 In an earlier draft of this paper, we studied the cross-sectional implications of a decomposion of the SMB factor for firms with high and low book-to-market equity, but found statistically weaker and economically generally inconclusive evidence. 3 While Duarte and Kapadia (2016) do not study the cross-sectional implications of GVD for risk premiums in asset markets, Table 9 in their paper is indicative of this observation. 4 Since there is no clear relation between value premium and firm size in Japan, we do not include Japan in our data set.…”

“…Unlike Hahn and Lee (2006) and Petkova (2006), we focus on differences between small-stock and big-stock book-to-market equity factors and investigate alternative ICAPM specifications. Our approach is also different from Duarte and Kapadia (2016) who construct a version of size factor which they label GVD (Goliath versus David). They show that GVD is strongly related to changes in aggregate business conditions.…”

“…They show that GVD is strongly related to changes in aggregate business conditions. Duarte and Kapadia (2016) study the forecasting ability of GVD and hence look at the time series properties of GVD, whereas we investigate the cross-sectional implications of the factors.…”

“…Perez-Quiros and Timmermann (2000) and Covas and Den Haan (2011) show that expected returns and financial characteristics of small firms exhibit much higher sensitivity to the business cycle and variables that measure credit market conditions. Duarte and Kapadia (2016) argue that increases in the firm's market value should signify economic contractions accompanied by increases in discount rates. They propose a new variable measured as the change in the market equity weight of the largest firms in the aggregate stock market and name it GVD (Goliath versus David).…”

What Goliaths and Davids among Swiss firms tell us about expected returns on Swiss asset markets

“…Our paper focuses on an intuitive predictor of asset returns and the state of the economy proposed by Duarte and Kapadia (2017). Changes of large firms' stock market capitalization relative to the changes in the aggregate stock market capitalization, "Goliath versus David" or GVD, forecast US stock and bond returns as well as macroeconomic variables.…”