Over-Extrapolation Of Past Returns Not Noise Is Responsible For Cheap Stocks

Are value returns higher when the value spread is large? If so, what happens at these times? Do value returns reflect rational compensation for risk, behavioral over-reaction, or pure noise in prices?

These are the questions Cliff Asness, John Liew, Lasse Heje Pedersen, and Ashwin Thapar set out to answer in a new research paper on the topic of value investing. Titled, Deep Value the paper provides new evidence on competing theories for the value premium in several assets. The researchers define "deep value" as "episodes where the valuation spread between cheap and expensive securities is
wide relative to its history".

One of the key findings of the paper is that price...