A Direct Test of Roll's Conjecture on the Firm Size Effect



    Search for more papers by this author
    • Graduate School of Business, University of Southern California, Los Angeles, California 90007, U.S.A. Comments welcome. I wish to thank Fischer Black, Michael Brennan, Kim Dietrich, Chap Findlay, Doug Joines, Terry Langetieg, Dick Roll, Alan Shapiro, and Robert H. Litzenberger for their helpful comments. Naturally, any remaining errors are this author's own doing.


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.