Abstract
We examine how time-series volatility of book-to-market (UNC) is priced in equity returns and the relative contributions of its book volatility (variations in earnings and book value) and market volatility components (shocks in required return). UNC captures valuation risk, so stocks with high valuation risk earn higher return. An investment strategy long in high-UNC firms and short in low-UNC firms generates 8.5% annual risk-adjusted return. UNC valuation risk premium is driven by outperformance of high-UNC firms facing higher information risk and is not explained by established risk factors and firm characteristics. This paper was accepted by Agostino Capponi, finance. Funding: The authors acknowledge financial support from Spain’s Ministry of Education [Grant EC02011-24928], Generalitat de Catalonia [Grant 2014-SGR-1079], Banc Sabadell, the Bank of Cyprus, and the European Social Fund. M. El Hefnawy acknowledges financial support from the Spanish Ministry of Science and Innovation [Grant PID2021-128994NA-I00]. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2023.4888 .
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