The Value Premium



    1. 1William E. Simon Graduate School of Business Administration, University of Rochester
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    • William E. Simon Graduate School of Business Administration, University of Rochester. This paper is based on chapter three of my doctoral dissertation at the Wharton School of the University of Pennsylvania. I thank my advisors Andrew Abel, Craig MacKinlay, Amir Yaron, and especially Joao Gomes for their training and inspiration. I also acknowledge helpful comments from Michael Brandt, Domenico Cuoco, Kent Daniel, Gary Gorton, Rick Green (the editor), Skander Van den Heuvel, Ming Huang, Donald Keim, Leonid Kogan, Martin Lettau, Ralitsa Petkova, Nick Souleles, Robert Stambaugh, Yunguang Yang, and participants at numerous workshops. I am especially indebted to an anonymous referee for many constructive criticisms. Naiping Liu taught me how to build Fortran 90 MEX routines in Matlab. Financial support from the Dean's Fellowship for Distinguished Merits at the Wharton School is gratefully acknowledged. All remaining errors are my own


The value anomaly arises naturally in the neoclassical framework with rational expectations. Costly reversibility and countercyclical price of risk cause assets in place to be harder to reduce, and hence are riskier than growth options especially in bad times when the price of risk is high. By linking risk and expected returns to economic primitives, such as tastes and technology, my model generates many empirical regularities in the cross-section of returns; it also yields an array of new refutable hypotheses providing fresh directions for future empirical research.