Final answer:
Banz (1981) found that the risk-adjusted returns of small firms were higher than those of large firms, which is consistent with the fact that higher-risk investments are associated with higher expected returns.
Step-by-step explanation:
Banz (1981) found that, on average, the risk-adjusted returns of small firms were higher than the risk-adjusted returns of large firms. This is consistent with the tradeoff between risk and return in investment choices. Riskier assets like stocks tend to have higher average returns to compensate for the higher degree of risk involved. If risky assets did not offer higher returns, investors would be less inclined to invest in them.
Banz (1981) discovered that the risk-adjusted returns of small firms were, on average, higher than those of large firms. This finding aligns with the well-established principle in finance that investments generally follow a tradeoff between expected return and the degree of risk involved.
Bank accounts, with low risk, offer very low returns, while bonds provide higher returns with higher risk. Stocks, being the riskiest, have the potential for higher returns still. The higher average return from stocks compensates investors for the associated higher risk. Strictly speaking, high-risk assets are expected to, and must, offer a higher average return to attract investment.