, Volume 31, Issue 1, pp 33-51
Date: 15 Mar 2007

Determinants of Equity Style

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This paper provides a unifying empirical treatment of propositions explaining equity style cycles with a four-factor model that combines risk factors central to style theory. Tests on style autocorrelations and performance over the period January 1979–December 2004 generally affirm theoretical expectations. We employ cointegration methodology to analyze the stationarity of style covariances and dissect the diversification contributions of styles. We document style diversification gains but discover an asymmetry: value gains are derived from small company stocks while growth benefits come from large stocks. The asymmetry implies portfolios comprised of independent large growth and small value styles since the twin small growth and large value styles are cointegrated and redundant diversifiers. Performance tests show superior performance by the independent styles over the sample period, two equal intertemporal periods, and an extended 5-year period that directly contradicts a risk based explanation. The influence of institutional traders on style trends is also documented. Our findings affirm the predictions of behavioral models and provide more empirical evidence of superior performance unrelated to risk or fundamentals.