Dec

7

This paper has an interesting comment:

We find interesting systematic shifts over the business cycle in the size of the market betas of so-called value stocks relative to growth stocks, suggesting that the former are systematically perceived as more risky than the latter, which may help to explain the puzzling ‘value premium.’

Of course, if value stocks were not perceived as more risky, their risk premium would be lower, and hence the stocks would be higher priced and no longer value stocks. Nevertheless, the overwhelming majority of investors believe that growth stocks are more risky than value stocks.

Allen Humbert comments:

Steve Ellison’s post reminds me of a study I have always wanted to conduct, but have failed to get around to (I don’t know why, I guess I have ADD) that would look to adjust returns by the underlying leverage of the companies (I suspect the debt to equity ratios of the average value stock are significantly higher than a typical growth stock). Since debt increases the probability of bankruptcy, since a low profit company with no debt cannot be driven into bankruptcy, value stocks are in fact riskier. I therefore hypothesize, and experience suggests, that value stocks outperform the most coming out of a recession when default rates are high. It is this fact, that I think makes high flying stocks, no matter how inflated the prices, poor shorts. A debt heavy company in trouble leaves everyone fighting for the last piece of flesh, hence the massive declines in the last dying days like when I lost $1 a share in the 15 minutes before the Enron bankruptcy (at least I didn’t loose the final $2.85).


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