Behavior and term structure of volatility for large and small companies

Abstract

Recent finance literature states that certain company characteristics are relevant to explain the returns expected, which is contrary to classic financial models such as the Capital Asset Pricing Model. The effect of company size in Brazil was investigated to verify if it explains another aspect of the relationship of risk versus return, which is volatility. The method used was to restructure the IBrX index (Sao Paulo Stock Exchange - Bovespa) to obtain a new index for large sized companies and also another for small companies. The behavior and term structure of volatility was analyzed using adjustments of the GARCH (1.1) and TARCH (1.1) models for each of the two new indices. It was concluded that, in general, small and large companies have different behaviors and term structures of volatility. Therefore, this size aspect should be taken into account for decisions, instrument pricing and risk management in financial considerations.