Explanation

The size effect anomaly refers to the empirical observation that small-cap stocks tend to outperform large-cap stocks on a risk-adjusted basis over long periods.

Key Points:

1. Definition of Size Effect: The size effect is the tendency for smaller companies (as measured by market capitalization) to generate higher returns than larger companies after adjusting for risk.

2. Historical Evidence: This anomaly was first documented by Rolf Banz in 1981, who found that small-cap stocks had higher average returns than large-cap stocks even after accounting for their higher beta.

3. Why Option C is Correct:

   • The size effect specifically relates to company size (market capitalization)
   • It's about risk-adjusted returns - small caps outperform even considering their typically higher volatility
   • This is a well-documented market anomaly that contradicts the efficient market hypothesis

4. Why Other Options are Incorrect:

   • Option A: Describes the value effect or P/E effect, not the size effect
   • Option B: Describes the dividend yield effect, not the size effect

5. Important Considerations:

   • The size effect has been less pronounced in recent decades
   • Some researchers argue it may be a compensation for higher transaction costs and lower liquidity in small-cap stocks
   • It's often considered alongside other anomalies like the value effect in multi-factor models (Fama-French three-factor model)

Correct Answer: C - This accurately describes the size effect anomaly where small-cap companies tend to outperform large-cap companies on a risk-adjusted basis.