Finance Papers

Document Type

Journal Article

Date of this Version

2007

Publication Source

The Journal of Finance

Volume

61

Issue

1

Start Page

55

Last Page

92

DOI

10.1111/j.1540-6261.2007.01201.x

Abstract

We propose a dynamic risk-based model that captures the value premium. Firms are modeled as long-lived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model implies that growth firms covary more with the discount rate than do value firms, which covary more with cash flows. When calibrated to explain aggregate stock market behavior, the model accounts for the observed value premium, the high Sharpe ratios on value firms, and the poor performance of the CAPM.

Copyright/Permission Statement

This is the peer reviewed version of the following article, which has been published in final form at http://dx.doi.org/10.1111/j.1540-6261.2007.01201.x. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving.

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Date Posted: 27 November 2017

This document has been peer reviewed.