Working Paper: NBER ID: w15993
Authors: Huseyin Gulen; Yuhang Xing; Lu Zhang
Abstract: Is the value premium predictable? We study time-variations of the expected value premium using a two-state Markov switching model. We find that when conditional volatilities are high, the expected excess returns of value stocks are more sensitive to aggregate economic conditions than the expected excess returns of growth stocks. As a result, the expected value premium is time-varying: it spikes upward in the high-volatility state, only to decline more gradually in the ensuring periods. However, out-of-sample predictability of the value premium is close to nonexistent.
Keywords: value premium; growth stocks; Markov switching model; expected returns; economic conditions
JEL Codes: G11; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high volatility (C58) | increased sensitivity of value stock returns to economic conditions (G17) |
| expected value premium (D46) | time-varying sensitivity to economic conditions (E32) |
| high volatility (C58) | upward spikes in expected value premium during recessions (E32) |
| low volatility (G19) | gradual decline in expected value premium (J17) |
| nonlinear Markov switching model (C32) | captures more time variations in expected returns (C22) |