Abstract
We investigate the relative risk of value to growth using a model that considers time-variation in investors’ risk preferences and return distributions. In this model, three well-known conventional equilibrium risk measures are allowed to regime-switch over time; beta, downside beta, and higher moments (co-skewness and co-kurtosis). Our empirical results show that none of these risk measures support that value is not riskier than growth in the post-1963 period. On the contrary, we find that the large positive value-minus-growth portfolio returns are explained by over-reaction (under-reaction) to positive (negative) market movements in a short, specific time periods, during which the average returns of the value-minus-growth portfolios are more than 2% a month. We propose a quasi-rational explanation for this asymmetric response, namely that the large positive value-minus-growth portfolio returns are driven by the return reversal subsequent to overreaction to signals.
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