The value premium and investors' appetite for risk

Abstract

The value premium is always discussed in the literature as a phenomenon driven by rational economic factors such as risks related to leverage, default or liquidity, cash flow or technological shocks. In this study, we use parametric and non-parametric methods with daily, weekly and monthly data for 1965–2019 to show that the value premium correlates with and is predictable by investors’ appetite for risk. The latter is captured using various measures of investor sentiment, including survey-based, stock market-based, press-based, Internet search-based and social media-based proxies. In addition, utilizing the quantile regression procedure, we find that the dependence between the value premium and some of the measures of risk appetite is non-linear and varies with the distribution of the data. Our findings are based on examining 100 portfolios created based on their book-to-market ratios and size. The results hold true for different sample periods and various model specifications.