Risk or Sentiment: Value and Size Premium under Terrorism

This study aims to identify the effect of terrorism on size and value premium using value weighted monthly returns for non-financial firms from January 2001 to December 2010. In addition to Independent size and BE/ME sorted portfolios, two dimensional portfolio formation methodology of Dimson, Nagel, and Quigley (2003) is also used. The results reveal that market, size, value premium and terrorism have a significant positive impact on stock returns. The study further suggests that value and size premiums are dependent on the level of psychosocial impact caused by terrorist incidents. Findings suggest that the small stocks generate higher returns than large stocks and the size premium occurs mainly during the months of higher terrorism activities. In contrast, value premium is more profound during the months of low (high) terrorist activities for portfolios sorted on one (two) dimension. This indicates that both size and BE/ME premiums are effected by investors sentiment.