Can Risk-Based Theories Explain the Value Premium?*

Can Risk-Based Theories Explain the Value Premium?* This paper shows that some of the most prominent risk-based theories offered as explanation for the value premium are at odds with data. The models proposed by Fama and French (1993), Lettau and Ludvingson (2001), Campbell and Vuolteenaho (2004), and Yogo (2006) can capture the cross-section of returns of portfolios sorted on book-to-market ratio and size, but not of portfolios sorted on book-to-market ratio and institutional ownership. These models generate economically large pricing errors in all the institutional ownership quintiles and each statistical test indicates that these pricing errors are significant. More generally, these results show that a minor alteration of the test assets can lead to a dramatically different answer regarding the validity of a given asset pricing model. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Finance Oxford University Press

Can Risk-Based Theories Explain the Value Premium?*

Review of Finance, Volume 11 (2) – Jun 1, 2007

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Publisher
Oxford University Press
Copyright
Copyright © The Author 2007. Published by Oxford University Press on behalf of the European Finance Association.
ISSN
1572-3097
eISSN
1573-692X
DOI
10.1093/rof/rfm014
Publisher site
See Article on Publisher Site

Abstract

This paper shows that some of the most prominent risk-based theories offered as explanation for the value premium are at odds with data. The models proposed by Fama and French (1993), Lettau and Ludvingson (2001), Campbell and Vuolteenaho (2004), and Yogo (2006) can capture the cross-section of returns of portfolios sorted on book-to-market ratio and size, but not of portfolios sorted on book-to-market ratio and institutional ownership. These models generate economically large pricing errors in all the institutional ownership quintiles and each statistical test indicates that these pricing errors are significant. More generally, these results show that a minor alteration of the test assets can lead to a dramatically different answer regarding the validity of a given asset pricing model.

Journal

Review of FinanceOxford University Press

Published: Jun 1, 2007

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