IDEAS home Printed from https://ideas.repec.org/a/eee/beexfi/v39y2023ics2214635023000485.html
   My bibliography  Save this article

Beta, value, and growth: Do dichotomous risk-preferences explain stock returns?

Author

Listed:
  • Montone, Maurizio

Abstract

I propose a Capital Asset Pricing Model in which investor demand exhibits a speculative component. In equilibrium, investors’ optimal trade-off between diversification and speculation generates predictable patterns for stocks with extreme book-to-market ratios. Using data on U.S. stocks, I find evidence consistent with the model predictions. I show that the value premium varies with investors’ propensity to speculate, and therefore includes a substantial behavioral component. Overall, the findings shed new light on the role of dichotomous risk-preferences in asset pricing.

Suggested Citation

  • Montone, Maurizio, 2023. "Beta, value, and growth: Do dichotomous risk-preferences explain stock returns?," Journal of Behavioral and Experimental Finance, Elsevier, vol. 39(C).
    • Handle: RePEc:eee:beexfi:v:39:y:2023:i:c:s2214635023000485
    DOI: 10.1016/j.jbef.2023.100834
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S2214635023000485
    Download Restriction: no
    File URL: https://libkey.io/10.1016/j.jbef.2023.100834?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    2. Lakonishok, Josef & Shleifer, Andrei & Vishny, Robert W, 1994. "Contrarian Investment, Extrapolation, and Risk," Journal of Finance, American Finance Association, vol. 49(5), pages 1541-1578, December.
    3. Chan, Louis K C & Hamao, Yasushi & Lakonishok, Josef, 1991. "Fundamentals and Stock Returns in Japan," Journal of Finance, American Finance Association, vol. 46(5), pages 1739-1764, December.
    4. J. Hirshleifer, 1966. "Investment Decision Under Uncertainty: Applications of the State-Preference Approach," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 80(2), pages 252-277.
    5. Stephen G Dimmock & Roy Kouwenberg & Olivia S Mitchell & Kim Peijnenburg, 2021. "Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field," The Review of Financial Studies, Society for Financial Studies, vol. 34(9), pages 4524-4563.
    6. Eric Ghysels, 1998. "On Stable Factor Structures in the Pricing of Risk: Do Time-Varying Betas Help or Hurt?," Journal of Finance, American Finance Association, vol. 53(2), pages 549-573, April.
    7. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    8. Malcolm Baker & Jeffrey Wurgler, 2006. "Investor Sentiment and the Cross‐Section of Stock Returns," Journal of Finance, American Finance Association, vol. 61(4), pages 1645-1680, August.
    9. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
    10. James L. Davis & Eugene F. Fama & Kenneth R. French, 2000. "Characteristics, Covariances, and Average Returns: 1929 to 1997," Journal of Finance, American Finance Association, vol. 55(1), pages 389-406, February.
    11. Hong, Harrison & Kostovetsky, Leonard, 2012. "Red and blue investing: Values and finance," Journal of Financial Economics, Elsevier, vol. 103(1), pages 1-19.
    12. Paul Gompers & Joy Ishii & Andrew Metrick, 2003. "Corporate Governance and Equity Prices," The Quarterly Journal of Economics, Oxford University Press, vol. 118(1), pages 107-156.
    13. Michael J. Cooper & Orlin Dimitrov & P. Raghavendra Rau, 2001. "A Rose.com by Any Other Name," Journal of Finance, American Finance Association, vol. 56(6), pages 2371-2388, December.
    14. Raymond D. Sauer, 1998. "The Economics of Wagering Markets," Journal of Economic Literature, American Economic Association, vol. 36(4), pages 2021-2064, December.
    15. Andrew Ang & Assaf A. Shtauber & Paul C. Tetlock, 2013. "Asset Pricing in the Dark: The Cross-Section of OTC Stocks," Review of Financial Studies, Society for Financial Studies, vol. 26(12), pages 2985-3028.
    16. Nicholas Barberis & Ming Huang, 2008. "Stocks as Lotteries: The Implications of Probability Weighting for Security Prices," American Economic Review, American Economic Association, vol. 98(5), pages 2066-2100, December.
    17. Bali, Turan G. & Cakici, Nusret, 2008. "Idiosyncratic Volatility and the Cross Section of Expected Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 43(1), pages 29-58, March.
    18. Ralitsa Petkova, 2006. "Do the Fama–French Factors Proxy for Innovations in Predictive Variables?," Journal of Finance, American Finance Association, vol. 61(2), pages 581-612, April.
    19. Malcolm Baker & Jeffrey Wurgler, 2007. "Investor Sentiment in the Stock Market," Journal of Economic Perspectives, American Economic Association, vol. 21(2), pages 129-152, Spring.
    20. Stambaugh, Robert F. & Yu, Jianfeng & Yuan, Yu, 2012. "The short of it: Investor sentiment and anomalies," Journal of Financial Economics, Elsevier, vol. 104(2), pages 288-302.
    21. Carhart, Mark M, 1997. "On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    22. Chen, Long & Petkova, Ralitsa & Zhang, Lu, 2008. "The expected value premium," Journal of Financial Economics, Elsevier, vol. 87(2), pages 269-280, February.
    23. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-738, August.
    24. Richard H. Thaler, 2008. "Mental Accounting and Consumer Choice," Marketing Science, INFORMS, vol. 27(1), pages 15-25, 01-02.
    25. Pastor, Lubos & Stambaugh, Robert F., 2003. "Liquidity Risk and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 111(3), pages 642-685, June.
    26. Elliott, Graham & Rothenberg, Thomas J & Stock, James H, 1996. "Efficient Tests for an Autoregressive Unit Root," Econometrica, Econometric Society, vol. 64(4), pages 813-836, July.
    27. Edmans, Alex, 2011. "Does the stock market fully value intangibles? Employee satisfaction and equity prices," Journal of Financial Economics, Elsevier, vol. 101(3), pages 621-640, September.
    28. Baker, Malcolm & Wurgler, Jeffrey & Yuan, Yu, 2012. "Global, local, and contagious investor sentiment," Journal of Financial Economics, Elsevier, vol. 104(2), pages 272-287.
    29. Hirshleifer, David & Teoh, Siew Hong, 2003. "Limited attention, information disclosure, and financial reporting," Journal of Accounting and Economics, Elsevier, vol. 36(1-3), pages 337-386, December.
    30. Ali, Ashiq & Hwang, Lee-Seok & Trombley, Mark A., 2003. "Arbitrage risk and the book-to-market anomaly," Journal of Financial Economics, Elsevier, vol. 69(2), pages 355-373, August.
    31. Holger M. Mueller & Paige P. Ouimet & Elena Simintzi, 2017. "Within-Firm Pay Inequality," Review of Financial Studies, Society for Financial Studies, vol. 30(10), pages 3605-3635.
    32. Eugene F. Fama & Kenneth R. French, 2006. "The Value Premium and the CAPM," Journal of Finance, American Finance Association, vol. 61(5), pages 2163-2185, October.
    33. Bogan, Vicki, 2008. "Stock Market Participation and the Internet," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 43(1), pages 191-211, March.
    34. Nagel, Stefan, 2005. "Short sales, institutional investors and the cross-section of stock returns," Journal of Financial Economics, Elsevier, vol. 78(2), pages 277-309, November.
    35. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    36. Chris Starmer, 2000. "Developments in Non-expected Utility Theory: The Hunt for a Descriptive Theory of Choice under Risk," Journal of Economic Literature, American Economic Association, vol. 38(2), pages 332-382, June.
    37. Liew, Jimmy & Vassalou, Maria, 2000. "Can book-to-market, size and momentum be risk factors that predict economic growth?," Journal of Financial Economics, Elsevier, vol. 57(2), pages 221-245, August.
    38. LUKE DeVAULT & RICHARD SIAS & LAURA STARKS, 2019. "Sentiment Metrics and Investor Demand," Journal of Finance, American Finance Association, vol. 74(2), pages 985-1024, April.
    39. Brad M. Barber & Terrance Odean, 2002. "Online Investors: Do the Slow Die First?," Review of Financial Studies, Society for Financial Studies, vol. 15(2), pages 455-488, March.
    40. Fama, Eugene F & French, Kenneth R, 1995. "Size and Book-to-Market Factors in Earnings and Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 131-155, March.
    41. Das, Sanjiv & Markowitz, Harry & Scheid, Jonathan & Statman, Meir, 2010. "Portfolio Optimization with Mental Accounts," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(2), pages 311-334, April.
    42. Conrad, Jennifer & Kapadia, Nishad & Xing, Yuhang, 2014. "Death and jackpot: Why do individual investors hold overpriced stocks?," Journal of Financial Economics, Elsevier, vol. 113(3), pages 455-475.
    43. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    44. R. David Mclean & Jeffrey Pontiff, 2016. "Does Academic Research Destroy Stock Return Predictability?," Journal of Finance, American Finance Association, vol. 71(1), pages 5-32, February.
    45. Jiang Luo & Avanidhar Subrahmanyam, 2019. "Asset pricing when trading is for entertainment," Review of Behavioral Finance, Emerald Group Publishing Limited, vol. 11(2), pages 220-264, June.
    46. Fama, Eugene F. & French, Kenneth R., 2015. "A five-factor asset pricing model," Journal of Financial Economics, Elsevier, vol. 116(1), pages 1-22.
    47. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross‐Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, February.
    48. Daniel, Kent & Titman, Sheridan, 1997. "Evidence on the Characteristics of Cross Sectional Variation in Stock Returns," Journal of Finance, American Finance Association, vol. 52(1), pages 1-33, March.
    49. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    50. Bhootra, Ajay, 2011. "Are momentum profits driven by the cross-sectional dispersion in expected stock returns?," Journal of Financial Markets, Elsevier, vol. 14(3), pages 494-513, August.
    51. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    52. Petkova, Ralitsa & Zhang, Lu, 2005. "Is value riskier than growth?," Journal of Financial Economics, Elsevier, vol. 78(1), pages 187-202, October.
    53. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279-279.
    54. Alok Kumar, 2009. "Who Gambles in the Stock Market?," Journal of Finance, American Finance Association, vol. 64(4), pages 1889-1933, August.
    55. Shefrin, Hersh & Statman, Meir, 2000. "Behavioral Portfolio Theory," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(2), pages 127-151, June.
    56. Eugene F. Fama & Kenneth R. French, 2004. "The Capital Asset Pricing Model: Theory and Evidence," Journal of Economic Perspectives, American Economic Association, vol. 18(3), pages 25-46, Summer.
    57. Hong, Harrison & Kacperczyk, Marcin, 2009. "The price of sin: The effects of social norms on markets," Journal of Financial Economics, Elsevier, vol. 93(1), pages 15-36, July.
    58. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory and Asset Prices," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 116(1), pages 1-53.
    59. Fama, Eugene F & French, Kenneth R, 1996. "Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    60. Thaler, Richard, 1980. "Toward a positive theory of consumer choice," Journal of Economic Behavior & Organization, Elsevier, vol. 1(1), pages 39-60, March.
    61. Brennan, Michael J. & Chordia, Tarun & Subrahmanyam, Avanidhar, 1998. "Alternative factor specifications, security characteristics, and the cross-section of expected stock returns," Journal of Financial Economics, Elsevier, vol. 49(3), pages 345-373, September.
    62. Valery Polkovnichenko, 2005. "Household Portfolio Diversification: A Case for Rank-Dependent Preferences," Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1467-1502.
    63. Conlisk, John, 1993. "The Utility of Gambling," Journal of Risk and Uncertainty, Springer, vol. 6(3), pages 255-275, June.
    64. Black, Fischer, 1972. "Capital Market Equilibrium with Restricted Borrowing," The Journal of Business, University of Chicago Press, vol. 45(3), pages 444-455, July.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Dittmann, Ingolf & Montone, Maurizio & Zhu, Yuhao, 2023. "Wage gap and stock returns: Do investors dislike pay inequality?," Journal of Corporate Finance, Elsevier, vol. 78(C).
    2. Montone, Maurizio & van den Assem, Martijn J. & Zwinkels, Remco C.J., 2023. "Company name fluency and stock returns," Journal of Behavioral and Experimental Finance, Elsevier, vol. 39(C).
    3. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, November.
    4. Amit Goyal, 2012. "Empirical cross-sectional asset pricing: a survey," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(1), pages 3-38, March.
    5. Montone, Maurizio, 2022. "Does the U.S. president affect the stock market?," Journal of Financial Markets, Elsevier, vol. 61(C).
    6. Stefan Nagel, 2013. "Empirical Cross-Sectional Asset Pricing," Annual Review of Financial Economics, Annual Reviews, vol. 5(1), pages 167-199, November.
    7. David Hirshleife, 2015. "Behavioral Finance," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 133-159, December.
    8. Committee, Nobel Prize, 2013. "Understanding Asset Prices," Nobel Prize in Economics documents 2013-1, Nobel Prize Committee.
    9. Avanidhar Subrahmanyam, 2010. "The Cross†Section of Expected Stock Returns: What Have We Learnt from the Past Twenty†Five Years of Research?," European Financial Management, European Financial Management Association, vol. 16(1), pages 27-42, January.
    10. Hou, Kewei & Xue, Chen & Zhang, Lu, 2017. "Replicating Anomalies," Working Paper Series 2017-10, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    11. Robert F. Stambaugh & Yu Yuan, 2017. "Mispricing Factors," Review of Financial Studies, Society for Financial Studies, vol. 30(4), pages 1270-1315.
    12. Fang, Yi & Niu, Hui & Lin, Yuen, 2023. "Ex-ante Valuation based on Prospect Theory," MPRA Paper 116386, University Library of Munich, Germany.
    13. Roland Füss & Massimo Guidolin & Christian Koeppel, 2019. "Sentiment Risk Premia In The Cross-Section of Global Equity," Working Papers on Finance 1913, University of St. Gallen, School of Finance, revised May 2020.
    14. Aboulamer, Anas & Kryzanowski, Lawrence, 2016. "Are idiosyncratic volatility and MAX priced in the Canadian market?," Journal of Empirical Finance, Elsevier, vol. 37(C), pages 20-36.
    15. Roland Fuess & Massimo Guidolin & Christian Koeppel, 2019. "Sentiment Risk Premia in the Cross-Section of Global Equity and Currency Returns," BAFFI CAREFIN Working Papers 19116, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    16. Kent Daniel & David Hirshleifer & Lin Sun, 2020. "Short- and Long-Horizon Behavioral Factors [Financial intermediaries and the cross-section of asset returns]," Review of Financial Studies, Society for Financial Studies, vol. 33(4), pages 1673-1736.
    17. Cooper, Michael J. & Gubellini, Stefano, 2011. "The critical role of conditioning information in determining if value is really riskier than growth," Journal of Empirical Finance, Elsevier, vol. 18(2), pages 289-305, March.
    18. Wang, Huijun & Yan, Jinghua & Yu, Jianfeng, 2017. "Reference-dependent preferences and the risk–return trade-off," Journal of Financial Economics, Elsevier, vol. 123(2), pages 395-414.
    19. Rocciolo, Francesco & Gheno, Andrea & Brooks, Chris, 2022. "Explaining abnormal returns in stock markets: An alpha-neutral version of the CAPM," International Review of Financial Analysis, Elsevier, vol. 82(C).
    20. Zura Kakushadze, 2015. "Heterotic Risk Models," Papers 1508.04883, arXiv.org, revised Jan 2016.

    More about this item

    Keywords

    Value premium; Speculative demand; Beta; Business cycle;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:beexfi:v:39:y:2023:i:c:s2214635023000485. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: https://www.journals.elsevier.com/journal-of-behavioral-and-experimental-finance .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.