Zhang (2005), titled "The Value Premium," is back in the news in academic circles. As flattered as I am with the latest attention, most of which I didn't exactly ask for, it occurs to me that I should check the Web of Science cites. While I do follow Google Scholar, which is only one click away, the last time I checked Web of Science was in December 2009, when I was putting a dossier together to come to Ohio State.
Back in the late 1990s and early 2000s, after the publication of Fama and French (1993, 1996), one of the more pressing tasks facing asset pricing theorists is to explain the value premium. Many of their works in this wave of theorizing were published around 2005. With 15+ years of time test, the table below shows the scorecard based on citations (that are at least objective):
I have put a recording together for "The Value Premium," in which I reflect on the methodological choices (largely implicit in this article) as well as open challenges in this theoretical literature. See below please as well as slides:
In the next-to-last section of the presentation above, I share my take on the recent disappointing performance of the value premium in the data:
First, the high-minus-low decile on book-to-market earns on average only 0.3% per month (t = 1.58) from January 1967 to December 2020. However, the high-minus-low decile on operating cash flow-to-market earns 0.8% (t = 4.18) in the same sample period. I view the evidence as saying that (i) book equity fails to capture intangibles per Lev's influential body of work. And (ii) the value of intangibles can still be ascertained, effectively, from cash flows (Penman 2009).
Second, as in book-to-market, operating cash flow-to-market has also suffered from poor recent performance (though to a lesser degree). Barring from the Covid shock, the past decade has been the longest boom in history. The causal mechanism based on costly reversibility and countercyclical price of risk in Zhang (2005) would predict that the value premium should come back going forward. (The expected value premium is countercyclical.) To invoke Karl Popper, this prediction is highly falsifiable. Time will tell.
Finally, please see below for a video presentation on "The CAPM Strikes Back? An Equilibrium Model with Disasters" (Bai, Hou, Kung, Li, and Zhang 2019) as well as slides. Among other things, this article extends Zhang's (2005) industry equilibrium to general equilibrium with heterogeneous firms.