What phenomenon suggests that small capitalization stocks earn higher returns compared to large capitalization stocks?

The phenomenon that suggests that small capitalization stocks earn higher returns compared to large capitalization stocks is known as the Small Cap Effect. This concept refers to the historical observation that, over time, smaller companies tend to outperform larger companies in terms of stock returns.

One reason for the Small Cap Effect is that small-cap stocks are often less researched and followed by analysts, which can lead to mispricing opportunities. Investors might undervalue these companies due to a lack of familiarity or liquidity, creating potential for higher returns as the market recognizes their value over time. Additionally, small-cap stocks can benefit from less competition and more agile management teams, allowing them to grow rapidly when opportunities arise.

The other options, while related to stock behavior in some capacity, do not specifically address the outperformance of small-cap stocks compared to large-cap stocks in the same way. Momentum persistence, for instance, deals with the tendency of stocks that have performed well in the past to continue performing well in the future, but it does not specifically pertain to market capitalization size. The P/E Ratio Effect relates to valuation metrics and their interpretation but does not directly connect with the size of the companies. Lastly, a negative feedback loop describes a situation where results perpetuate the conditions that caused them, which