Does Aggregate Uncertainty Explain Size and Value Anomalies?
29 Pages Posted: 13 Sep 2014 Last revised: 9 Aug 2019
Date Written: April 13, 2015
Following seminal works of Knight (1921) and Ellsberg (1961), we distinguish uncertainty from risk and examine the impact of aggregate uncertainty on return dynamics of size and book-to-market ratio sorted portfolios. Using VVIX as a proxy for aggregate uncertainty and controlling for market risk, volatility risk, correlation risk, and the variance risk premium, we document significant portfolio return exposures to aggregate uncertainty. In particular, portfolios that contain small and value stocks have significant and negative uncertainty betas, whereas portfolios of large and growth stocks exhibit positive and significant uncertainty betas. Using a quasi-natural experimental setting around the financial crisis, we confirm the differential sensitivity of small vs. big and value vs. growth portfolios to aggregate uncertainty. We posit that due to their negative uncertainty betas, uncertainty-averse investors demand extra compensation to hold small and value stocks. Our results offer an uncertainty-based explanation to size and value anomalies.
Keywords: Uncertainty, vol-of-vol, VVIX, size, value
JEL Classification: C4, G13, G32
Suggested Citation: Suggested Citation