More On Value Premium And Risk
Today concludes our two-part series on the research aimed to provide explanations for risk. We’ll pick up with more research on the topic.
We looked at three different papers in Part I as we sought to assess the value premium through the lens of risk, and today we turn to a fourth paper: The 2005 study “Understanding Size and the Book-to-Market Ratio: An Empirical Exploration of Berk’s Critique.” The authors concluded that there were various rationales simultaneously active in driving the size and book-to-market (BtM) ratio effects. Among the significant drivers are distress risk and less liquidity, which increases trading risks and costs. Both contribute to higher BtM ratios and higher expected returns.
The fifth paper, the 2005 study, “Asset Pricing and the Illiquidity Premium,” asked the question, Does illiquidity attract a premium in equity markets—is it another risk factor in asset pricing? Stocks that are illiquid not only have lower trading volume but are characterized by wider bid/offer spreads.
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