#26 – Value (Book-to-Market) Anomaly

Authors: Qiao

Title: Conditional Market Exposures of the Value Premium

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2687528

Abstract:

Value strategies exhibit a large positive beta if contemporaneous market excess returns are positive, and a small beta if contemporaneous market excess returns are negative. Value also has a large positive beta after bear markets, but a small beta after bull markets. These facts hold for equity-value strategies in 21 countries, and to a lesser extent for three non-equity-value strategies. Betas conditional on contemporaneous market returns are able to capture expected return variation associated with the book-to-market ratio. These betas partially explain the value premium, and are related to a larger cash-flow risk of value strategies.

Notable quotations from the academic research paper:

"Value strategies exhibit asymmetric betas: a large and positive up-market beta when the contemporaneous market excess returns are positive, and a small or negative down-market beta when the contemporaneous market excess returns are zero or negative. Value strategies also exhibit time-varying betas: after a string of good market returns, or a bull market, value has a small negative bull-market beta. After a string of poor market returns, value has a large positive bear-market beta. Asymmetric betas and time-varying betas also exist for international equity-value strategies, and to a lesser extent, in three non-equity-value strategies.

Asymmetric betas and time-varying betas are plausibly linked through mean-reversion of market returns. Value has a large positive beta in bear markets when market returns have been low. Because market returns tend to mean-revert, expected market returns are high when realized returns have been low. Therefore, value has a large positive beta when expected market returns are high. Value also has a small negative beta when expected market returns are low. Taken together, the time-varying betas combined with mean-reverting market returns translate into asymmetric contemporaneous betas.

Conditional market exposures shed light on the mechanism of value strategies. A decomposition of beta into its cash-flow and discount-rate components reveals asymmetric betas mostly come from cash-flow betas, consistent with the idea that value securities have higher cash-flow risk."

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