Size matters : capital market size and risk-return profiles

In this paper we propose a simple approach that allows us to track the impact of capital market size on the risk/return profile of capital markets. The thought motivating the study is that markets of different size ought to behave differently even when they are composed of agents whose risk attitudes are all alike. Smaller, or shallower, markets are less able to pool and spread risks than are deeper markets and we might expect this to be reflected in the observed risk/return profiles of capital markets of differing size. The paper’s ultimate aim is to show why a small-to-medium sized capital market such as Australia’s might be less willing to subscribe risky ventures than larger markets even if the same investment opportunities were available to both types of market and the stakeholders in both markets have similar attitudes to risk. A corollary of this proposition is that R&D activity – which is a form of investment in relatively risky activity – might be expected to be proportionately larger in an economy with a large capital market than is the case in a small capital market.17 page(s