Further evidence on the value premium on the UK stock market

Kristina Møller

Student thesis: Master thesis


This master thesis provides further evidence on the value premium on the UK stock market. The main hypothesis to be tested in this thesis is whether evidence supporting the presence of a value premium on the UK stock market is still to be found. Furthermore, different hypotheses put forth in previous research, as to why the value premium has appeared in the past, are to be examined. In replicating the UK stock market, the FTSE All share Index is used. The empirical analysis conducted in this thesis is based on the methodology presented in Lakonishok et al. (1994). Several company characteristics have been found to be applicable in identifying value stocks and thus separating them from growth stocks. The four value indicators used in this thesis are price earnings ratios, dividend yields, book to market values and growth in sales ranks. According to these indicators, stocks are divided into deciles and portfolios are found, comprising either value or growth stocks. Single year portfolio returns, together with average five year returns are calculated. According to all value indicators, bar dividend yield, distinct return patters are detected going from the most extreme value portfolio to the most extreme growth portfolio. Furthermore, the recent financial crisis does seem to have an impact on the returns found. The explanatory power of the value indicators is tested in explaining the variation in stock returns. Evidence showing the significance of the book to market variable is found. Moreover, the significance of the discovered value excess returns is tested. Both single year returns together with accumulated three and five year returns are found significant according to all strategies, with the exception of the one based on dividend yields. Value stocks yield higher returns than growth stocks. Different explanations presented in previous research are examined in order to explain the appearance of the value excess returns found in this thesis. To explain the value premium by concepts of modern finance theory, different risk measures are investigated and compared for the value and growth portfolios. No evidence to support the risk hypothesis is found. Neither does the UK stock market appear inefficient; however a possible bias from the size effect may be present in the data foundation. From a behavioural finance perspective, the presence of the value premium found is sought to be explained by the extrapolation hypothesis stating that the premium is an outcome of mispricing. Evidence rejecting this hypothesis is not found.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2009
Number of pages81