Contrarian investment strategies: An assessment of the value premium in context to recessions

Rebekka Petersen & Philip Arnstedt

Student thesis: Master thesis


Contrarian investment strategies have been present for decades, generating superior returns for the investors. Investors who follow the contrarian investment strategy are known as value investors. Value investors follow a strategy where stocks with low prices relative to book value and other measures of fundamental value are bought, to be able to generate abnormal returns. The magnitude of the value premium is huge and it has been persistent on the American stock market. We have investigated how the value premium performs in general and around recessions in order to draw conclusions on the strategy that a value investor should follow when the economy is faced with a recession. We have found that the value premium, sorted on Book-to-Market values, exists throughout our period of investigation from 1947 until 2009 on the American stock market, generating an average quarterly premium of more than 3 % for the investor. We have also found that the value premium is skewed towards the right, implying that value stocks have a higher upside potential than growth stocks. On average in the four quarters prior to recessions the quarterly value premium is 0.92 %. During the 11 different recessions in our time period of investigation, we found that the average quarterly value premium is 1.37 %. Therefore, we come to the conclusion that value stocks perform worse prior to recessions and during recessions than on average. We have also found that in the four quarters after recessions the value premium is positive in ten out of 11 different recessions, which indicates that there is a clear tendency towards higher returns on value stocks after recessions. The average quarterly value premium is 5.95 %. We have established that the standard finance theory does not explain the value premium. The traditional systematic risk measure, beta, is on average lower for our value portfolio than for our growth portfolio. This completely contradicts the traditional finance theory. We believe that the explanation is found within the behavioral finance theory. Investors are subject to several kinds of decision biases, which originate from limited cognitive capacity. We expect that as long as naive investors are challenged by limited cognitive capacity and keep extrapolating past performance into the future the value premium will continue to exist, hence generating possibilities for the value investors.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2010
Number of pages117