The Value Premium and Beta Premium Sensitivity using a Direct Market Estimates Approach

I study the relative risk of value and growth stocks using beta premium sensitivities and find that, on average, value stocks are less risky than growth stocks based on this measure. I find that value stock betas tend to covary less with the expected market risk premium than growth stock betas. Value stocks are therefore less susceptible to time-varying risk during recessionary periods when the expected market risk premium is high. My finding does not offer support for a risk-based explanation of the value premium. The beta premium sensitivity is a measure of the covariation between a stock's time-varying beta and the expected market risk premium. I derive expected stock returns, the expected market risk premium and expected market volatility using a direct market estimates approach. This is the first study, to my knowledge, that investigates the relative risk of value and growth stocks in this manner. Under the direct market estimates approach I use professional stock analysts' forecasts and the CBOE VIX index to derive expected stock returns and the expected market volatility respectively. I also use an instrumental (conditioning) variables approach for comparison, as has been used in previous research, under which I derive expected returns using predictive regressions. My results using instrumental variables are in the opposite direction to those using direct market estimates, whereby I find that value stocks are riskier than growth stocks on average based on beta premium sensitivities. The divergent results do not appear to be caused by the tendency for professional stock analysts' forecasts to exhibit optimism, as both the direct market estimates and instrumental variables approaches exhibit more optimism for growth stock forecasts relative to value stock forecasts