Study of Asymmetric Risk Premium in Value and Growth Stocks Based on P/E Ratio

Abstract

In this thesis we predict asymmetric risk premium in bothvalue and growth stock portfolios. There are two competingapproaches to explain value premium: Market Over-reactionHypothesis based on which agents overstate future returns on growthstock, and Rational Market Risk Hypothesis that says value stocks areinherently riskier than growth stocks. Rational Market RiskHypothesis has two different explanations: Leverage Effect andVolatility Feedback. We use asymmetric GARCH-M model (whosecodes are written by Dr. Shapoor Mohamadi, University of Tehran) tostudy which of these hypotheses can explain asymmetric risk premiumin6 portfolios (3 value and 3 growth stock portfolios).Usingasymmetric QGARCH-M model, this paper tests the predictions of thetwo hypotheses. Also we examine whether returns exhibit a positive(negative) risk premium resulting from a negative (positive) shock andthe relative size of any premium. The population of this study includesall stock companies and non-financial stock companies during 2002 to2010. The results of this study confirm Volatility Feedbackhypothesis. Further, the impacts for value stocks are more than that ofgrowth stocks, and for negative shocks are more than that of positiveshocks.

Keywords

• asymmetric risk premium
• leverage effect
• overreaction
• value and growth portfolio
• volatility feedback