Summary of Academic Research on Value/Growth

Section 1 (Introduction)

In this chapter, we will consider the size and value investment anomalies and how these anomalies evolved into the cornerstone of the Fama-French Risk model which is now accepted by most academics as the appropriate risk model for US equity markets.  We’ll begin with a brief introduction to both anomalies and review the development of the Fama-French Risk model.  Next, we’ll examine the rational (risk), structural, and behavioral explanations for both anomalies.  We’ll also look at some possible investment strategies, potential returns, and their suitability for individual investors.  The chapter concludes with a look at the application of size and value strategies to a variety of asset classes and international markets.

Section 2 (Development of the Fama-French Risk Model)

Prior to the development of the Fama-French risk model, the Capital Assets Pricing Model (CAPM) developed by Sharpe (1964)[1], Lintner (1965)[2] and Black (1972)[3]was accepted as the appropriate risk model for U.S. equity markets.  According to the CAPM, stock prices depend only on the risk-free rate of return, the equity market premium (the return of the market portfolio in excess of the risk-free return), and a stock’s Beta, a number which describes the relationship between the stock’s return and the return of the market portfolio.  However, research soon revealed consistent pricing anomalies, situations where the CAPM didn’t accurately price securities.  Chief among these were the size and value anomalies.

The size anomaly, first documented by Banz (1981), is the empirical finding that small companies earn greater risk-adjusted returns than their larger counterparts.   The value anomaly is the finding that value stocks, those stocks with low prices relative to their fundamentals (book value, earnings, dividends, etc.), tend to outperform their growth, or glamour, counterparts, stocks on the other end of the spectrum.  Common measures of value are the Earnings to Price, Book to Price, and Cash Flow to Price ratios (E/P, B/P, and CF/P, respectively).  Prior to the development of the Fama-French Risk model, several researchers including Stattman (1980)[4], Rosenberg (1985)[5], and Chan (1991)[6] had documented a BE/ME premium, while others including Ball (1978)[7]had documented an E/P premium.


[1] Sharpe, William F., 1964, Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk, Journal of Finance, (19), pp. 425-442.

[2] Lintner, J., 1965. The valuation of risk assets and selection of risky investments in stock portfolios and capital budgets, Review of Economics and Statistics 47, 13-37.

[3] Black, F. 1972. Capital Market Equilibrium with Restricted Borrowing, Journal of Business, 45, 444-454.

[4] Stattman, D. 1980. Book Values And Stock Returns. The Chicago MBA: A Journal Of Selected

Papers, 4, 25-45.

[5] Rosenberg, Barr, Kennetb Reid, and Ronald Lanstein, 1985, Persuasive evidence of market

inefficiency. Journal of Portfolio Management 11, 9-17.

[6] Chan, Louis K., Yasushi Hamao, and Josef Lakonishok, 1991, Fundamentals and stock returns

in Japan, Journal of Finance 46,1739-1789.

[7] Ball, Ray, 1978, Anomalies in relationships between securities’ yields and yield-surrogates.

Journal of Financial Economics 6, 103-126.

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