on returns in that it shows a relationship between the past, the forecasted,
and the actual future growth rates that is largely consistent with the predic-
tions of the extrapolation model.
5 .Are Contrarian Strategies Riskier?Two alternative theories have been proposed to explain why value strate-
gies have produced higher returns in the past. The first theory says that they
have done so because they exploit the mistakes of naive investors. The pre-
vious section showed that investors appear to be extrapolating the past too
far into the future, even though the future does not warrant such extrapola-
tion. The second explanation of the superior returns to value strategies is
that they expose investors to greater systematic risk. In this section, we ex-
amine this explanation directly.
Value stocks would be fundamentally riskier than glamour stocks if, first,
they underperform glamour stocks in some states of the world, and second,
those are on average “bad” states, in which the marginal utility of wealth is
high, making value stocks unattractive to risk-averse investors. This simple
theory motivates our empirical approach.
To begin, we look at the consistency of performance of the value and
glamour strategies over time and ask how often value underperforms glam-
our. We then check whether the times when value underperforms are reces-
sions, times of severe market declines, or otherwise “bad” states of the
world in which the marginal utility of consumption is high. These tests do
not provide much support for the view that value strategies are fundamen-
tally riskier. Finally, we look at some traditional measures of risk, such as
beta and the standard deviation of returns, to compare value and glamour
strategies.
Table 8.6 and figure 8.2 present the year-by-year performance of the
value strategy relativeto the glamour strategy over the April 1968 to April
1990 period. We consider differences in cumulative returns between deciles
(9, 10) and (1, 2) for C/P and B/M, and between groups (3, 1) and (1, 3) for
(C/P, GS) over one-, three-, and five-year holding horizons starting each
year in the sample (1968, 1969, etc.). The arithmetic mean across years for
each horizon is reported at the bottom of each column along with t-
statistics for the test of the hypothesis that the difference in returns between
value and glamour portfolios is equal to zero. Standard errors for t-tests in-
volving overlapping three- and five-year horizons are computed using the
method of Hansen-Hodrick (1980), assuming annual MA(2)and MA(4)pro-
cesses, respectively.
The results show that value strategies have consistently outperformed
glamour strategies. Using a one-year horizon, value outperformed glamour
in 17 out of 22 years using C/P to classify stocks, in 19 out of 22 years
300 LAKONISHOK, SHLEIFER, VISHNY