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The investment value of the value premium

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  • Brailsford, Tim
  • Gaunt, Clive
  • O'Brien, Michael A.

Abstract

Value investment strategies are premised on research that value stocks outperform growth stocks. However, the research findings are dependent on the portfolio classification method that is used to sort stocks using the attributes of size and book-to-market ratios. Different stock markets contain different distributions of stocks, and in many markets, illiquidity concerns combined with a lack of investment scale, effectively create barriers to practical portfolio formations that align with the research. This study conducts a case study on one such market (Australia) and demonstrates that different methods of portfolio formation lead to different conclusions. For example, previous studies in Australia find evidence of the value premium only being present in the largest stocks, in contrast to the results from the US market. However, we find a value premium that is systematic across all size categories and generally increases inversely with size. Further, we find the well-documented size premium largely disappears once portfolios are formed that better represent feasible investment sets and once ‘penny dreadfuls’ are removed. Finally, asset pricing tests support the existence of a value premium in Australian stock returns when a more appropriate portfolio formation method is employed.

Suggested Citation

  • Brailsford, Tim & Gaunt, Clive & O'Brien, Michael A., 2012. "The investment value of the value premium," Pacific-Basin Finance Journal, Elsevier, vol. 20(3), pages 416-437.
    • Handle: RePEc:eee:pacfin:v:20:y:2012:i:3:p:416-437
    DOI: 10.1016/j.pacfin.2011.12.008
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    4. Vu, Van & Chai, Daniel & Do, Viet, 2015. "Empirical tests on the liquidity-adjusted capital asset pricing model," Pacific-Basin Finance Journal, Elsevier, vol. 35(PA), pages 73-89.
    5. Robert J. Bianchi & Michael E. Drew & Eduardo Roca & Timothy Whittaker, 2017. "Risk factors in Australian bond returns," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 57(2), pages 373-400, June.
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    7. Zhong, Angel & Limkriangkrai, Manapon & Gray, Philip, 2014. "Anomalies, risk adjustment and seasonality: Australian evidence," International Review of Financial Analysis, Elsevier, vol. 35(C), pages 207-218.
    8. Docherty, Paul & Chan, Howard & Easton, Steve, 2013. "Can we treat empirical regularities as state variables in the ICAPM? Evidence from Australia," Pacific-Basin Finance Journal, Elsevier, vol. 22(C), pages 107-124.

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    More about this item

    Keywords

    Value premium; Book-to-market effect; Investments; Fund performance;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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