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The value premium and economic activity: Long-run evidence from the United States


This article tests for the existence of a long-run relationship between the US value premium price index (VPPI) and economic activity. Although it is largely accepted that there exists a value premium in returns, there has been little investigation into the wealth index associated with a strategy that is long in value and short in growth stocks. Evidence of such a relationship would provide support that the premium results from the presence of non-diversifiable risk inherent in value stock. Our results support cointegration between the VPPI and industrial production (IP), inflation, money supply (MS) and interest rates. Further examination of the long-run relationship reveals a significant negative relationship between the value premium and both IP and MS, and a significant positive relationship with long-run interest rate. A negative but insignificant relationship is found between the value premium and inflation. Overall, these results suggest that value stocks are more sensitive to bad economic news, whereas growth stocks are more sensitive to good economic conditions. This can be rationalised by the view that value stocks are typically purchased by institutional investors who value the income (dividend) payments. In contrast, growth stocks, in which the return is largely generated from future growth opportunities, are purchased by individuals who may be adopting short-term strategies and ‘trend-chasing’, hence not adopting fully rational strategies, and whose actions may depend on the level of economic well-being and confidence.

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  1. Ten year long-term government bond return is used as LIR instead of short-term interest rate because first, short-term interest rate is found to be integrated in different order as other variables; second, LIR is found to be better than short-term interest rate in response to the nominal risk-free component of the discount rate in stock valuation models in the US market (Mukherjee and Naka, 1995).

  2. Ibbotson Association does not have seasonal adjusted data for IP and MS. In this case, we obtain data for IP and MS from DataStream.

  3. The full details of the tests are suppressed here but available upon request.

  4. SIC is used rather than Akaike information criterion because SIC is proved to have best result when choosing correct lag length. See Kerry Patterson (2000).

  5. I also test other lag lengthens with restriction that r does not have full rank. The coefficient results are similar to the cases k=6 and k=7.

  6. The critical value of two-side t-test at 5 per cent significant level is from −1.96 to 1.96.

  7. Capital adjustment cost measures the flexibility of the firm to adjust capital. The higher the adjustment cost the firm faces, the less flexibility it has to adjust their capital, and the riskier its return will be.

  8. As a robustness check, the Johansen procedure was re-estimated excluding CPI given its insignificance; however, results for the remaining series were qualitatively unaffected. The full results are available upon request.


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Correspondence to David G McMillan.

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2recently completed her PhD examining the three-factor model at the University of Aberdeen.

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Black, A., Mao, B. & McMillan, D. The value premium and economic activity: Long-run evidence from the United States. J Asset Manag 10, 305–317 (2009).

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  • value premium
  • economic activity
  • cointegration