The Value Premium and Time-Varying Unsystematic Risk

Chris Brooks, Xiafei Li and Joelle Miffre
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Xiafei Li: Cass Buisness School, City University (UK)
Joelle Miffre: EDHEC Business School (France)

ICMA Centre Discussion Papers in Finance from Henley Business School, University of Reading

Abstract: Recent research has discussed the possible role of unsystematic risk in explaining equity returns. Simultaneously, but somehow independently, numerous other studies have documented the failure of the static and conditional capital asset pricing models to explain the differences 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. In accordance with existing studies, we find that the static CAPM has no explanatory power for the value premium, and that firm size has only a limited role to play. Our results show that the conditional variance specification incorporating time-varying idiosyncratic risk can fully capture the post-1963 value premium and that the value premium is a compensation for exposure to time-varying risk. This conclusion is robust to different characteristics of value and growth stocks and to the country under review (US and UK).

Keywords: Value premium; time-varying unsystematic risk; factor model. (search for similar items in EconPapers)
JEL-codes: G12 G14 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2007-04
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