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Publications [#42547] of Dana Kiku

Working Papers

  1. Is the Value Premium a Puzzle? (Fall, 2005)
    (last updated on 2006/07/12)

    Abstract:

    This paper provides an economic explanation of the value premium puzzle, differences in price/dividend and Sharpe ratios of value and growth assets, volatilities of ex-post returns on the two stocks and their correlation. I consider a model that features two equally important ingredients: a small persistent component in cash-flow growth dynamics and the Epstein-Zin recursive utility preferences. In the model, as in the data, cash flows of value firms are highly exposed to low-frequency fluctuations in aggregate consumption, whereas growth firms' dividends are mainly driven by short-lived consumption news and risks related to fluctuating economic uncertainty. I show that the dispersion in long-run risks is the key mechanism that allows the model to quantitatively replicate the magnitude of the historical value premium, resolving the puzzle. Furthermore, heterogeneity in systematic risks across firms helps account for the whole transitional dynamics of value and growth returns, as well as the empirical failure of the CAPM and C-CAPM. In addition, the model is able to successfully accommodate the time-series behavior of the aggregate equity market.

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