The UK Value Premium An Assessment of Possible Explanations: An Assessment of Possible Explanations

Edoardo Marangon & Marco Pietro Valerio

Student thesis: Master thesis

Abstract

This thesis investigates the underlying reasons of the presence of value premium in the UK Stock Market by confronting the explanations of Behavioural Finance and Standard Finance Theory. While, in general, scholars and professionals alike agree on the superior performance of value strategies, more controversial is the explanation of such outperformance. Behavioural Finance offered an alternative interpretation of the market anomaly through the introduction of concepts belonging to the psychology of individuals. We first look for the existence of the value premium in the UK stock market for the period 1982-2014 using a methodology similar to that of Lakonishok, Shleifer and Vishny, 1994. This method includes the use of simple one-dimensional classifications of glamour and value stocks that rely on measures of past growth or expected future performance, specifically Price to Earnings, Dividend Yield, Price to Book, Assets Growth and Cash Flow to Assets. We further investigate if the value premium found can be explained by simple measures of risk, such as exposure to systematic risk, volatility and bad states performance. We therefore replicate a simple extrapolation model to test whether there is evidence of cognitive biases in the average investor’s decision-making process. We thus discuss the implications of the results in light of the explanations of Behavioural Finance. The main findings are that value premium exists in the UK context. In particular, the strategies based on the low Price to Book and low Price to Earnings are the most profitable. A risk-based explanation do not seem to suffice in understanding the presence of the anomaly in the UK stock market. On the other hand, Behavioural Finance offers a plausible and more comprehensive alternative.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2016
Number of pages129