Value Effect and Macroeconomic Risk

We study to what extent macroeconomic risk drives the positive cross-sectional relation between future stock returns and relative firm value, such as book-to-market ratio and earnings-to-price ratio. We provide evidence that value stocks are risker than growth stocks. We show that value stocks have higher risk loadings than growth stocks on the growth rate of industrial production, the term premium, and the default premium. We also show that the risk loadings and risk premiums estimated with respect to Chen, Roll, and Ross [1986] factors account for more than half of the average return spreads between value portfolios and growth portfolios. Our evidence suggests that risk plays an important role in explaining the value effect. Our results provide implications to value and growth investment