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Is the Value Premium a Proxy for Time-Varying Investment Opportunities? Some Time-Series Evidence

Published online by Cambridge University Press:  01 February 2009

Hui Guo ,
Robert Savickas ,
Zijun Wang  and
Jian Yang
Hui Guo
Affiliation:
College of Business Administration, University of Cincinnati, Cincinnati, OH 45221. hui.guo@uc.edu
Robert Savickas
Affiliation:
School of Business, George Washington University, 2023 G Street NW, Washington, DC 20052. savickas@gwu.edu
Zijun Wang
Affiliation:
Private Enterprise Research Center, Texas A&M University, College Station, TX 77843. z-wang@neo.tamu.edu
Jian Yang
Affiliation:
Business School, University of Colorado Denver, Denver, CO 80202. jian.yang@ucdenver.edu
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Abstract

We uncover a positive stock market risk-return tradeoff after controlling for the covariance of market returns with the value premium. Fama and French (1996) conjecture that the value premium proxies for investment opportunities; therefore, by ignoring it, early specifications suffer from an omitted variable problem that causes a downward bias in the risk-return tradeoff estimation. We also document a positive relation between the value premium and its conditional variance, and the estimated conditional value premium is strongly countercyclical. The latter evidence supports the view that value is riskier than growth in bad times, when the price of risk is high.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 44 , Issue 1 , February 2009 , pp. 133 - 154
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2009

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