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Quantitative Applications in Finance (FIN236)
Assignment 1 Answer Template
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QUESTION 1 (word limit 800 words)

Part A

1. Dividend Growth Rates and Positive Correlation – Dimson and Marsh (‘DM’) affirm the previous periods of small cap outperformance (particularly in the United States and the UK) concurred with superior real dividend growth from small caps. Conversely the subsequent under performance coincided with inferior dividend growth[1]. Thus DM implies the reason for the reversal related to underlying business performance of small caps relative to large companies rather than investor’ sentiment. Specific evidence to support this view was that from 1988 to 1997 small cap dividends grew at a rate 2% p.a. less than large cap stocks, which was in direct contrast to the period 1955 to 1988. Furthermore, over the same period, the small cap price/dividend multiple fell by 4.2%. When these factors are added together the approximate 6% small cap reversal is clear[2].

2. Differences in sector composition – portfolio concentration measures the extent to which a portfolios