The Equity as a Call Option Hypothesis for the Value Premium

The value premium is the empirical observation that low market/book “value” stocks have higher returns than high market/book “growth” stocks. In this paper, we investigate and present evidence for an “equity as a call option hypothesis” for the value premium. Volatility decreases the options-leverage of equity, which decreases expected return. At the same time, volatility increases value for equities with options features and, thus, it increases market/book. Because volatility has opposite impacts on expected return and value, there is a value premium