In their August 2005 paper entitled “Value Versus Growth: Stochastic Dominance Criteria”, Abhay Abhyankar, Keng-Yu Ho and Huainan Zhao apply stochastic dominance techniques to assess the relative performance of value and growth investment strategies in U.S. equity markets over the past half century. These techniques: (1) compare entire return distributions (not just means or medians); (2) are independent of specific asset pricing models; and, (3) require only minimal assumptions about investor preferences. In this application, the assumptions are that investors always want more wealth, are risk-averse and accept small high-probability losses in exchange for huge low-probability returns. With these assumptions, stochastic dominance implies generation of greater wealth. Using a full sample covering 1951-2003 and a sub-sample covering 1963-1990 from the Kenneth French database, they find that:
- Whether defined based on book-to-market, earnings-to-price or cash flow-to-price, value stocks outperform growth stocks over the full sample period and (less strongly) during economic boom periods. In other words, investors who prefer more to less, investors who are risk-averse and investors who accept small high-probability losses for huge low-probability gains would all have preferred value stocks over growth stocks over these intervals.
- There are no significant stochastic dominance relations between value and growth stocks during
recession periods. Neither outperforms. - Results are inconsistent with risk-based (efficient market) model predictions but better explained by behavioral models.
In summary, value beats growth overall and during expansions. During recessions, value and growth tie.
