Anomalies are phenomena arising from some surprising market results and are seen as contradictions to the theories of asset pricing behavior and the theories of efficient market. Usually anomalies indicate market inefficiencies and profit opportunities. They had been analyzed in many academic literatures by scholars and various forms of well known anomalies could be found in documents, such as the value effect, the low PE effect, the market overreaction, the January effect and the weekend effect and so on. But there are many suspicions about the existence of those anomalies as some forms of anomalies disappeared after certain period, such as the small firm effect, and they were treated simply as statistical aberrations. If there really are anomalies in financial market, opportunities for investors to make more profit than normal can definitely be explored. One form of anomalies mentioned above, a small firm effect, is emphasized and analyzed from the cross sectional financial markets and time series in this essay. The anomalies, especially the small firm effect, and its implications for market efficiency are introduced first. And then the reasons for the small firm effect are explored to explain the existence of anomaly and its effects. The final goal in analyzing anomalies is actually to promote some suggestions and strategies to investors and managers. And at last there comes the conclusions.
The term anomaly was first introduced by Kuhn in 1970. It is described in the discussion of emergence of scientific discoveries as a violation to the paradigm induced expectation which is governed by the normal science (Kuhn, 1970, p.52). Anomaly appears only against the background provided by the paradigm which means in the financial market, anomaly is defined relative to the definition of the normal return (Constainides, Harris & Stulz, 2003, p.4). The ideas that discoveries of market anomalies implicate the inefficiency of market and the failure of asset pricing model are supported by many scholars (Fama, 1970; Banz, 1981). And empirically in many stock exchanges around the world, the pricing of assets is not following the rules of Efficient Market Hypothesis (EMH). But to Ball (1978) and Keim (2008), the refuse to the hypothesis based on an information efficient market and an equilibrium model relied profit, such as the CAPM, is not necessary to suspect the market efficiency. So the supports believe the existence of the size effect as the empirical studies indicate, the protestors believe the exploration of the size effect as the measurement and databases errors indicate.
