Is the Value Premium a Puzzle

Abstract

This paper provides an economic explanation of the value premium, differences in price/dividend ratios of value and growth assets and variance-covariance structure of their realized returns within the long-run risks model of Bansal and Yaron (2004). Consistent with time-series properties of observed cash-flow data, value firms exhibit higher exposure to low-frequency fluctuations in aggregate consumption than growth firms do. This is the key input that allows the model to justify the magnitude of the historical value premium. Furthermore, heterogeneity in systematic risks across firms helps account for the violation of the CAPM and C-CAPM, resolving the puzzle.

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