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The Value Premium and Time-Varying Volatility

Authors

  • Xiafei Li,

    1. The authors are respectively, from Nottingham University Business School; ICMA Centre, University of Reading; and EDHEC Business School, Nice, France. They would like to thank the editor, Norman Strong, and an anonymous referee for very useful comments on a previous version of this paper. They are also grateful to J. Doukas, H. Lohre, N. Todorovic and seminar participants at the EDHEC-EFM 2008 symposium for their comments. All remaining errors are the authors' own.
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  • Chris Brooks,

    1. The authors are respectively, from Nottingham University Business School; ICMA Centre, University of Reading; and EDHEC Business School, Nice, France. They would like to thank the editor, Norman Strong, and an anonymous referee for very useful comments on a previous version of this paper. They are also grateful to J. Doukas, H. Lohre, N. Todorovic and seminar participants at the EDHEC-EFM 2008 symposium for their comments. All remaining errors are the authors' own.
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  • Joëlle Miffre

    Corresponding author
    1. The authors are respectively, from Nottingham University Business School; ICMA Centre, University of Reading; and EDHEC Business School, Nice, France. They would like to thank the editor, Norman Strong, and an anonymous referee for very useful comments on a previous version of this paper. They are also grateful to J. Doukas, H. Lohre, N. Todorovic and seminar participants at the EDHEC-EFM 2008 symposium for their comments. All remaining errors are the authors' own.
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* Address for correspondence: Chris Brooks, ICMA Centre, University of Reading, Whiteknights, Reading RG6 6BA, UK.
e-mail: C.Brooks@rdg.ac.uk

Abstract

Abstract:  Numerous studies have documented the failure of the static and conditional capital asset pricing models to explain the difference in returns between value and growth stocks. This paper examines the post-1963 value premium by employing a model that captures the time-varying total risk of the value-minus-growth portfolios. Our results show that the time-series of value premia is strongly and positively correlated with its volatility. This conclusion is robust to the criterion used to sort stocks into value and growth portfolios and to the country under review (the US and the UK). Our paper is consistent with evidence on the possible role of idiosyncratic risk in explaining equity returns, and also with a separate strand of literature concerning the relative lack of reversibility of value firms' investment decisions.

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