University of Chicago - Booth School of Business
Juhani T. Linnainmaa
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)
July 1, 2015
Fama-Miller Working Paper
Chicago Booth Research Paper No. 12-18
A firm's book-to-market is a function of its expected return, expected profitability, and future book-to-market. The part of book-to-market that correlates with past price movements is less informative about the latter two components, and therefore more informative about expected returns. The optimal exposure to value doubles when an investor hedges the risks shared by different types of value stocks. Our decomposition shows that value outperforms growth when investors receive good news about future economic growth, and it explains why the characteristics-versus-covariances test sometimes rejects the risk-based explanation for the value premium.
Number of Pages in PDF File: 52
Keywords: Value premium, risk and mispricing, factor models, firm characteristics
Date posted: June 13, 2012 ; Last revised: July 23, 2015
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