304 LAKONISHOK, SHLEIFER, VISHNY
covariance between the negative realizations of the value minus glamour re-
turn and this payoff-relevant factor should be high and the risk-premium
associated with that factor should also be quite high.
While it is difficult to reject a risk-based explanation that relies on an un-
specified multifactor model, we can examine a set of important payoff-
relevant factors that are likely to be associated with large risk premia. If,
after examining the association between the negative relative returns to
value and this set of factors, we are unable to make sense of the higher aver-
age returns on value strategies, we can conclude that a risk-based explana-
tion is unlikely to work except by appealing to large risk premia on factors
that are a priori of lesser payoff relevance.
In examining the payoff relevant factors, we do not restrict ourselves to
tightly parameterized models such as the Sharpe-Lintner model or the con-
sumption Capital Asset Pricing Model (using consumption data) which are
too likely to lead to rejection of risk-based explanations. For example, we
do not assume that beta is the appropriate measure of exposure to the mar-
ket factor. Instead, we proceed nonparametrically and examine the perfor-
mance of value strategies in extreme down markets. Moreover, we allow
for the possibility that the distribution of stock returns does not provide a
complete characterization of good and bad states of the world. Barro
(1990) and others find that, while the stock market is useful in predicting
economic aggregates such as GNP growth, the R^2 is only around 0.4 in the
post war subperiod.
Some evidence on the performance of value and glamour strategies in
bad states of the world can be gleaned from table 8.6 and figure 8.2. Accord-
ing to the National Bureau of Economic Research, there were four recessions
during our sample period: a mild one from December 1969 to November
1970, a very deep one from November 1973 to March 1975, and also sig-
nificant ones from January 1980 to July 1980 and July 1981 to November
- An examination of table 8.6 shows that the value strategy did about
the same or somewhat better than glamour just before and during the 1970
recession, did much better around the severe recession of 1973 to 1975, did
somewhat worse in 1979 to 1980, and did significantly better in 1981 to
1982.^15 It is implausible to conclude from this that value strategies did par-
ticularly badly in recessions, when the marginal utility of consumption is
especially high.
A second approach is to compare the performance of value and glamour
portfolios in the worst months for the stock market as a whole. Table 8.7,
Panel 1 presents the performance of our portfolios in each of four states of
the world; the twenty-five worst stock return months in the sample based
on the equally weighted index, the remaining eighty-eight negative months
(^15) Recall that returns are computed starting at the end of April of the year listed through
April of the following year.