Expected Return and the Value Premium
26 Pages Posted: 14 May 2007 Last revised: 25 Aug 2008
Date Written: December 1, 2007
Empirical research has shown that within a cross-section of stocks, investor return increases with book-to-market ratio. The reason is in dispute. One side argues that the market is inefficient; the other, that value stocks are riskier. Statistical analysis of historical data has not resolved the issue. We take a theoretical approach, which suggests that the higher returns for value stocks can be explained without the introduction of risk. Our theory leads to an equation for expected return, which differs from realized return through elimination of a speculative noise factor. The theory defines fundamental factors that determine investor return, and is confirmed by empirical correlations reported by others.
Keywords: Growth Stocks, Value Stocks, Stock Screens, Value Premium, Expected Return, Efficient Markets, Book-to-Market, Share Repurchase, Risk Factors, Valuation, Dividend Payout, Factors Affecting Return, Investor Behavior, Investment Policy, Dividend Policy, Share Buy-back, noise factor
JEL Classification: C20, G12, G30, G31
Suggested Citation: Suggested Citation