Beta, Value, and Growth

Abstract

I propose a Capital Asset Pricing Model in which investor demand exhibits a speculative component. In equilibrium, investors' optimal trade-off between diversification and speculation generates predictable patterns for stocks with extreme book-to-market ratios. Consistent with the model predictions, I show that simple trading strategies on value and growth stocks yield positive and robust abnormal returns in the period from 1926 to 2017. The results are especially strong among stocks characterized by a large presence of naive investors, and during economic downturns. Overall, the findings shed new light on the economic meaning of the value premium.

Keywords: Value premium; Speculative demand; Beta; Business cycle.

JEL Classification: G11, G12, G14