Investor Uncertainty and the Superior Performance of Value Stocks
38 Pages Posted: 2 Mar 2003
Date Written: September 12, 2002
Several empirical studies show that investment strategies that favor the purchase of stocks with low prices relative to dividends, earnings, book values or other measures of value yield higher returns. Some of these studies imply that investors are too optimistic about (glamour) stocks that have had good performance in the recent past and too pessimistic about (value) stocks had had performed poorly. Others argue that value strategies are fundamentally riskier. In this paper we examine whether value stocks are riskier than glamour stocks over the 1976-1998 period. Consistent with Fama and French (1992, 1996), our findings suggest that the return advantage of value strategies reflects compensation for bearing risk. We find this risk to be associated with investor uncertainly, manifested in security analysts' divergence of opinion about the future growth in earnings of value stocks. Multifactor asset pricing tests show that investor uncertainty risk is important in explaining the superior return of value stocks. The results also suggest that the uncertainty risk factor is a state variable that predicts economic growth.
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