Are Canadian small cap stocks a separate asset class? : a mean-variance spanning approach

This paper introduces size based indices of Canadian markets using all firms listed on the Toronto Stock Exchange from December 31, 1969 to December 31, 2004 to assess the extent to which small-cap portfolios can enlarge the efficient frontier for investors. Both traditional and step-down spanning tests are performed. Furthermore, we evaluate the economic impact of adding Canadian small cap stocks by measuring the changes in the global minimum variance frontier and improvement in the Sharpe Ratio of the optimal portfolio. Canadian small-cap (as well as micro-cap) portfolios are shown to behave as separate classes, with performance enhancing effects for the entire period as well as various subperiods examined. The results are robust to the inclusion of alternative international indices to the benchmark portfolios, and policy constraints do not necessarily reduce the benefits from diversification