1. The UK Value Premium – An Assessment of Possible Explanations
Master’s Thesis - May 2016
Edoardo Marangon
Marco Pietro Valerio
Abstract
This thesis investigates the underlying reasons of the presence of value premium in the UK
Stock Market by confronting the explanations of Behavioural Finance and Standard Finance
Theory. While, in general, scholars and professionals alike agree on the superior performance
of value strategies, more controversial is the explanation of such outperformance. Behavioural
Finance offered an alternative interpretation of the market anomaly through the introduction of
concepts belonging to the psychology of individuals. We first look for the existence of the
value premium in the UK stock market for the period 1982-2014 using a methodology similar
to that of Lakonishok, Shleifer and Vishny, 1994. This method includes the use of simple one-
dimensional classifications of glamour and value stocks that rely on measures of past growth
or expected future performance, specifically Price to Earnings, Dividend Yield, Price to Book,
Assets Growth and Cash Flow to Assets. We further investigate if the value premium found
can be explained by simple measures of risk, such as exposure to systematic risk, volatility and
bad states performance. We therefore replicate a simple extrapolation model to test whether
there is evidence of cognitive biases in the average investor’s decision-making process. We
thus discuss the implications of the results in light of the explanations of Behavioural Finance.
The main findings are that value premium exists in the UK context. In particular, the strategies
based on the low Price to Book and low Price to Earnings are the most profitable. A risk-based
explanation do not seem to suffice in understanding the presence of the anomaly in the UK
stock market. On the other hand, Behavioural Finance offers a plausible and more
comprehensive alternative.