Market Over-reaction and Rational Market Risk in value and growth stocks in Tehran Securities Exchange

Abstract:In this paper we study asymmetric risk premium on both value and growth stocks. There are two competition explanations for risk premium: Market Over-reaction Hypothesis that agents overstate future returns on growth stock, and Rational Market Risk Hypothesis that has two different explanations: Leverage Effect and Volatility Feedback. We use asymmetric GARCH-M model to study which of these hypotheses can explain asymmetric risk premium on 4 portfolios (2 value and 2 growth stock portfolios). Using asymmetric QGARCH-M models, this paper tests these hypotheses. Also we examining whether returns exhibit a positive (negative) risk premium resulting from a negative (positive) shock and the relative size of any premium. Results show in 2 portfolios volatility feedback can explain asymmetric risk premium. The volatility feedback explanation for asymmetry in variance would suggest that all shocks increase expected future volatility. Furthermore, we find that returns sensitivity in value stock is greater than growth stock that supports the rational risk interpretation. And second a negative shock increases volatility greater than a positive shock of equal magnitude, in accordance with both the leverage and volatility feedback hypotheses. We use non-financial monthly returns data from March 2001 to February 2011 in 2 scenarios.