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Worldwide Variation in the Value Premium

Posted in Value Premium

Is the value premium consistent across equity markets worldwide? In their May 2013 paper entitled “Value around the World”, Nilufer Caliskan and Thorsten Hensyz measure returns for stock portfolios sorted on value in 41 countries and investigate how cultural differences affect the magnitude of the value premium. Each month in each country, they sort stocks based on prior-year price-to-book value ratio into equally weighted fifths (quintiles), designating the bottom quintile as the value portfolio and the top quintile as the growth portfolio. The value premium is the difference in average monthly gross returns between the value and growth portfolios. They use survey responses from economics students (for the 2006-2010 International Test on Risk Attitudes) to derive two measures of cultural differences, patience and risk aversion. Patience is the percentage of respondents willing to wait for a higher return, and risk aversion is the average reward-to-potential loss ratio required by respondents.¬†Using monthly stock prices and annual book values for firms in 41 country markets as available during December 1979 (various series begin in the 1980s, 1990s and 2000s) through December 2011, along with the specified survey responses,¬†they find that:

  • Russia, Chile and Italy are the least patient countries, while northern European countries are the most patient. The U.S and the UK are mid-range.
  • The most risk-tolerant countries are Australia, New Zealand and Malaysia, while the most risk-averse are Poland, Hong Kong, Thailand and Canada. The U.S. (UK) is relatively risk-tolerant (risk-averse).
  • The gross value premium is positive in all 41 country markets, ranging from a monthly 0.16% in the Netherlands to 4.8% in Romania and exhibiting statistical significance in 34 markets.
  • Across countries, the value premium relates negatively to patience and positively to risk aversion. In other words, the value premium tends to be largest (smallest) in countries that are least (most) patient and most (least) risk-averse.
  • Average stock volatility also relates negatively to patience and positively to risk aversion, but cultural effects on the value premium persist after controlling for average stock volatility.

In summary, evidence indicates that the equity value premium is pervasive worldwide, but varying in magnitude according to the patience and risk aversion of local investors.

Cautions regarding findings include:

  • Estimates of country value premiums are gross. Accounting for trading frictions, shorting costs and shorting feasibility would reduce and possibly eliminate premiums.
  • Trading frictions may vary across country markets in a way that suppresses differences in gross value premiums (highest frictions in the least patient and most risk-averse countries).
  • Patience and risk aversion may differ for investors and economics students.
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