Investor Information, Long-Run Risk, and the Duration fo Risky Assets
Mariano M. Croce
Value stocks have higher average returns than growth stocks. At the same
time, the duration of value stocks' cash flows is considerably shorter than
that of growth stocks. We show that when investors can fully distinguish
short- and long-run consumption risk components of dividend growth
innovations, only exposure to long-run consumption risk generates
significant risk premia, implying that high-return value stocks should be
long-duration assets, contrary to the historical data. By contrast, when
investors observe the change in consumption and dividends each period but
not the individual components of that change (limited information), exposure
to short-run risk can generate large risk premia, implying that value stocks
become short-duration assets while growth stocks are long-duration assets,
as in the data. The limited information specifications we explore are not
only consistent with the cash flow duration properties of value and growth
stocks, they also explain the observed value premium, the higher Sharpe
ratios of value stocks, the failure of the CAPM to account for the value
premium, and the success of the HML factor of Fama and French (1993) in
explaining the value premium.
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