Searching for Deep Value: Existence, Magnitude and Volatility of the German Value Premium (1992-2014). Evidence From the DAX

Abstract

This thesis aims to contribute to the limited existing literature on the German valuepremium by investigating the performance of a value strategy and a growth strategy onthe German stock market using DAX data from 1992 to 2014. The DAX is a dynamiclarge cap index whose composition dynamics are based on a stock’s marketcapitalization and trading volume.An exploration of the behavioral explanation of the value premium as argued byLakonishok, Shleifer and Vishny (1994) is provided based on Tversky (1974),Kahneman and Tversky (1979) and Barberis and Thaler (2002). While the theorieswithin traditional finance are founded in the efficiency of the markets and the capitalasset pricing model, behavioral finance combines aspects of cognitive psychology withfinancial theory. The focus in this study is placed on cognitive biases, irrationalbehavior and limits to arbitrage to explain the possibility of systematically generatingexcess returns.Stocks for the value and growth portfolios are selected using four sorting metrics: thebook-to-market ratio, the earnings yield, the cash flow yield and the dividend yield.Using these metrics value and growth portfolios were created and rebalanced for everyyear of the sample period. The rebalancing takes places on June 1st every year, in orderto avoid ex-post bias and maintain a realistic level of operationality of this investmentstrategy.The dividend yield proved to be the most effective metric for selecting value stocks,with an average annual premium of 11.36 percentage points. The book-to-market andearnings yield are found to be less effective than the dividend yield, with an averageannual value premium of 6.37 percentages points and 1.36 percent, respectively. Thecash flow yield has resulted in a negative value premium (-1.22). The return differencebetween value stocks and growth stocks has decreased over time.A comparison of the full sample (1992-2014) with the most recent ten years (2005-2014) of the sample indicates that value premia for all metrics except for the dividendyield have decreased significantly over time.