Abstract
This paper presents a quantitative, general equilibrium model of the value premium and equity premium. Value firms are temporarily low productivity firms, which will eventually experience high cash flows. The present value of these temporally distant cash flows is especially sensitive to equity premium movements, which are driven by changes in consumption volatility. The value premium is the reward for bearing this sensitivity. Empirical evidence verifies that value firms have higher cash-flow growth. The data also show that value stock returns are more sensitive to consumption volatility shocks.
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