The Value Premium: Systematic Risk due to Costly Reversibility, Errors in Expectation, or Lack of Recognition?

Recent theoretical research in finance argues that the value premium is due to a systematic risk factor attributable to costly reversibility. In testing the costly reversibility hypotheses, the study recognises that there are a number of other possible explanations that need to be controlled for. Behavioural finance literature suggests that the value premium may be driven by errors in expectation about future earnings performance. An additional identified risk factor that is priced in the market is investor recognition, and since firms with capital investments that are difficult to reverse may be difficult to analyse, this may in itself contribute to the observed value premium. Empirical proxies for each of these explanations are likely to be correlated in the cross-section. The objective of this study is to jointly examine each of the explanations to determine the incremental economic significance of each theory. Email: [email protected]