What Drives the Value Premium? Risk versus Mispricing: Evidence from International Markets

Abstract

Value stocks outperform growth stocks. The academic literature provides two competing interpretations on what drives the value premium: exposure to risk factors or mispricing of securities. Existing empirical studies, which are largely based on U.S. data, have not conclusively rejected one theory in support of the other. Up to this point, large scale studies based on multiple countries have not been conducted. Past studies also employ data which end before 2000 and do not cover the tech bubble, the housing bubble, the global financial crisis and the European debt crisis, when the relative performance of value stocks was extremely volatile. Applying Fama and MacBeth (1973) two-stage cross-sectional regression and Daniel and Titman (1997) double-sorted portfolio methods to 30 years of cross sectional data from 23 developed countries, we find evidence that the value premium is driven by mispricing.

Keywords: value strategy, value premium, value factor, value investing

JEL Classification: G14, G12, G10