Abstract

Many papers have shown evidence that suggests that value stocks outperform growth stocks. Value stocks, in general, refer to stocks with a low price-earnings ratio (P/E), a high book to market ratio (B/M), low sales growth, small size and exhibit financial distress. Growth stocks, in contrast, are larger in size, have a higher P/E, a lower B/M, have higher growth rate and are more sound financially. If markets are efficient, all stocks should offer the same risk-adjusted returns. If value stocks outperform growth stocks, where do the premium returns come from? Is this due to higher risk or from mispricing? This paper tests to see if high book to market stocks have higher risks to compensate for their higher returns. In an effort to measure risk, various metrics are employed including bankruptcy rates, standard deviations, betas, historical Value at Risk (VAR) and extreme loss statistics. Results show that although high book to market ratio portfolios offer higher returns, they appear to have lower risks. Therefore, the evidence offered in this paper tends to support the notion that mispricing is the driving force behind the observed findings.