The Wider the Value Spread, the Larger the Expected Value Premium: Evidence from Russell 1000 Component Stocks

Abstract

In recent years, there has been a lively debate among academics and investment professionals regarding the presence of the value premium. However, our study, which utilizes the robust panel smooth transition regression (PSTR) model developed by González et al. (2005), has yielded a significant discovery. We have identified a substantial average value premium of 17.27% annually for Russell 1000 components from 2010 to 2019. This finding confirms the significant positive (negative) impact of value spreads on the expected returns for small-value (big-growth) stocks, offering a fresh perspective. Importantly, our research aligns with Baba et al.’s (2021) conclusion that the value premium increases with a wider value spread. This study also validates that over 30% of small-value firms shifted to big-growth firms in the Consumer Discretionary, Information Technology, and Real Estate sectors over the sample years. Finally, our robustness test demonstrates a significant value premium that persists out-of-sample from 2020 to 2022. These findings hold profound implications for the investment community, rendering them more pertinent and actionable and potentially guiding investment strategies in the future.

Keywords: Value Premium, Value Spread, Market-Adjusted Returns, Russell 1000 Component Stocks, Panel Smooth Transition Regression Model