The Puzzling Counter-Cyclicality of the Value Premium

I propose a simple consumption model with mental accounting in which investments have both a fundamental and speculative motive. The model predicts that speculative assets should have a lower book-to-market ratio, exhibit a negative alpha and yield lower returns in bad economic times. Using post-war data on U.S. stocks, I find evidence that supports these predictions. In particular, I show that that high book-to-market (value) stocks have better insurance properties than low book-to-market (growth) stocks despite earning a persistent premium. As such, the findings are at odds with the predictions of standard finance models.

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