There is a Growth Premium After All

The conventional wisdom argues that the growth stocks are riskier to earn a higher premium. However, the empirical evidence points out that the value stocks, which are classified based on the book-to-market ratio, tend to have a higher premium. To solve this tension, this paper decomposes the book-to-market ratio into two components, a trend component, and a temporary (innovation) component. Both economic interpretation and empirical results show that the temporary component has a strong negative relationship with future cross-sectional stock returns even after controlling for main return predictors including Book-to-Market ratio, while the trend component is positively associated with the value premium. Therefore, consistent with conventional wisdom, our results confirm that there is growth premium captured by the temporary component of the book-to-market ratio.

Keywords: Book-to-Market ratio, Temporary Component of B/M, Growth Option, Growth Premium

JEL Classification: G12

Suggested Citation: Suggested Citation

Jia, Yuecheng and Yan, Shu and Yang, Haoxi, There is a Growth Premium After All (February 6, 2018). Available at SSRN: https://ssrn.com/abstract=2988137 or http://dx.doi.org/10.2139/ssrn.2988137