Does Value Premium Exist in India?

Samit Paul* and Madhusudan Karmakar**

Prior research in Indian equity market has failed to fully document the well-known
influences of size and book-to-market effects that have been evidenced in other
markets. So, the question remains as to whether value premium exists in India or
whether it has simply failed to be adequately explored. Moreover, no robustness check
has been performed on this. This study uses buy-and-hold strategy for a short span
of one quarter to a relatively longer span of two years over the 10-year period from
June 2003 to September 2013 and finds no evidence of value premium in the Indian
market. This explains the presence of an anomaly as the results are contrary to what
have been found in other countries.

Introduction
Determinants of share price movements are one of the key concerns for researchers in the
field of Finance. The earlier studies have developed single-factor models and multi-factor
models in order to explain such movements. The groundbreaking work of Fama and French
(1992) shifted the focus on several key factors, including size and book-to-market ratio.
Prior researches in the area have largely been confined to the US market may be because
of accurate data availability regarding equity prices and company-specific financial
information. Using Indian data, only a few studies have been performed, and mostly these
are limited in depth and time series coverage.
A few studies have attempted to test the three-factor model in India. The results have
been found to be mixed and generally weak as compared to the US findings. For instance,
Bahl (2006) tests the three-factor model using 79 stocks listed in BSE-100 stock market
index, while Connor and Sehgal (2001) study the three-factor model using data of 364
companies from the June 1989 to March 1999. These studies find evidence that the three-
factor model suggested by Fama and French (1992) explains returns better than the traditional
Capital Asset Pricing Model (CAPM), but the results are not so much conclusive. For example,
there is mixed evidence for parallel market, size and book-to-market factors in earnings of
* Doctoral Student (Finance and Accounting), Indian Institute of Management, Lucknow, IIM Road,
Lucknow 226013, Uttar Pradesh, India; and is the corresponding author. E-mail: fpm13005@iiml.ac.in
** Professor (Finance and Accounting), Indian Institute of Management, Lucknow, IIM Road, Lucknow
226013, Uttar Pradesh, India. E-mail: madhu@iiml.ac.in

54 2015 IUP. All Rights Reserved. The IUP Journal of Applied Economics, Vol. XIV, No. 2, 2015
stocks in India. The findings of the said studies indicate about (negative) size premium and
insignificant (positive) value premium, although robustness check has not been performed.
This study, to the best of our knowledge, presents the first comprehensive examination
of the presence of value premium in the Indian market. The paper is structured as follows:
it reviews the existing literature available in this context, followed by the discussion of data
and methodology used in the study. Subsequently, the results are documented with analysis,
and finally, conclusion is offered.

Literature Review
The seminal study by Fama and French (1992) posits that there are a few factors which are
capable of explaining variation in equity returns. They successfully analyze the influence and
association of different key attributes on portfolio returns. Among a number of factors, two
have become generally accepted and widely used. They are: size and book-to-market ratio.
The relationship between size of a firm and corresponding returns is well documented in
literature. Banz (1981) is the first to describe an inverse relationship between market value
of equity and returns. Returns to the smaller sized firms significantly outperform returns of
the larger size stock. Beedles et al. (1988) find that the size premium is more pronounced in
Australia.
In addition to size and beta, Fama and French (1992) introduce book-to-market ratio as
a distinguishing factor for explaining returns. Specifically, they show that portfolios formed
on the basis of serially ranked book-to-market ratios exhibit differential performance. Portfolios
comprising firms with high book-to-market ratios usually outperform portfolios which
comprise firms with low book-to-market ratios. This is termed as value premium. This is
because firms with high book-to-market ratios have their value embedded in their book
valuation, whereas firms with low book-to-market ratios have their value embedded in market
expectations of future growth opportunities.
Fama and French (1993) argue that these two variables, size and book-to-market ratio,
can be interpreted as the pricing factors. This claim has been criticized due to lack of
theoretical justification (Lakonishok et al., 1994; Daniel and Titman, 1997; Daniel et al.,
2001; and Brennan et al., 2004). Moreover, there are criticisms on data snooping too (Black,
1993; Kothari et al., 1995; and Haugen and Baker, 1996). However, numerous studies have
established the relevance of size and book-to-market factors in the US equity market. These
factors are relevant to explain variations in stock returns (Fama and French, 1996 and 2006;
Barber and Lyon, 1997; Davis et al., 2000; and Griffin, 2002).
Studies on international data have been harder to conduct because book values over a
long time series are generally not available. The study by Chui and Wei (1998) on the data of
Asia-Pacific region has found supportive evidence for the same. In Australia, Halliwell
et al. (1999) attempt to test the Fama-French three-factor model. The results of their study
fail to support value-growth premium. Thereafter, Gaunt (2004), Durand et al. (2006), and

Does Value Premium Exist in India? 55

Gharghori et al. (2007) examine whether the three-factor model proposed by Fama and
French can explain portfolio returns since the mid-1990s in Australia. They find that although
the Small-Minus-Big (SMB) factor is significant in explaining portfolio returns, there is
mixed support for the High-Minus-Low (HML) factor being significant. Most recently,
Brailsford et al. (2012) have found the presence of value premium in Australia.
In the case of India, as discussed earlier, three-factor model is found to be better than the
traditional CAPM in explaining returns (Connor and Sehgal, 2001; and Bahl, 2006). However,
inconclusive results have been found while explaining the value premium as no check of
robustness has been performed. This study remedies such situation by analyzing a new
dataset of stocks of the Indian stock market over a more than 10-year period starting from
June 2003 to September 2013.

Objectives
The purpose of this study is twofold. First, the paper attempts to find out whether value
premium exists in Indian stock market. Second, it also tries to explore the minimum time
period required to observe such value effect. The subsequent analysis in this study focuses
on complete robustness checking of the existence of value premium over different durations
quarterly, half-yearly, three-quarterly, yearly and bi-yearly.

Data and Methodology

The sample is constructed over a 41-quarter period starting from July 2003 to September
2013. Hence, the study encompasses the period of global growth as well as global recession.
In order to define the size factor, market capitalization of the individual firms has been
calculated. Following previous literature, we consider product of the adjusted closing price
and number of shares outstanding in a particular period as the market capitalization of the
firm in that period. While defining the value factor, we have considered the Price-to-Book
(PB) ratio which is just the inverse of book-to-market ratio and the stocks have been defined
accordingly. This means stocks with higher PB ratio have been considered as growth stocks
and those with lower PB ratio have been considered as value stocks.
For the relevant accounting information, the CMIE PROWESS database has been used.
Stocks of BSE-500 index are used as a representative of Indian stock market. To be consistent
with previous literature and because of differential structure possessed by financial entities,
only non-financial stocks have been considered as a sample. Moreover, we have to consider
such companies, data of which are available since April 2003. After considering all these
constraints, we have finally zeroed down to 281 stocks of India as a sample.
For market capitalization and PB ratio, we extract the quarterly accounting data from
PROWESS database. For calculating monthly return of stocks, we take daily adjusted closing
prices for each stock as available in PROWESS database. Then, we calculate the monthly
return of each stock by adding the log return of all the days of that particular month for
individual stock.

56 The IUP Journal of Applied Economics, Vol. XIV, No. 2, 2015

Portfolio Formation
The 200 largest firms by market capitalization are first ranked at the end of each quarter by
their PB ratios and are assigned to one of the five PB portfolios, where each portfolio
contains an equal number of stocks. The first portfolio (growth) contains 20% of stocks
with the highest PB ratio. The next 20% of stocks are assigned to Portfolio 2. The process
continues till the last portfolio (value) containing the last 20% of stocks with the lowest PB
ratio. These breakpoints are marked, and on the basis of this, other 81 listed firms are
assigned into five PB portfolios.
Individually, each firm is ranked by market capitalization again at the end of each quarter,
and assigned to one of five size portfolios with largest firms that make up 75% of total
market capitalization assigned to Portfolio 1 (large). Portfolio 2 contains the firms making
up the next 15% of market capitalization. Similarly, Portfolio 3 contains firms that make up
the next 5%, and Portfolio 4 the next 3% of market capitalization. The firms that make up
the remaining of the total market capitalizations are assigned to Portfolio 5 (micro). This
procedure is similar to that followed by previous studies (Fama and French, 1993 and 2006;
and Brailsford et al., 2012)
In this process, each stock is assigned to one size portfolio and to one PB portfolio. The
intersection of these two classes leads to the formation of our 25 size-PB portfolios. This
process is rolled forward each quarter and value-weighted returns are calculated. This results
in a series of 126 monthly returns covering the period April 2003 to September 2013 for the
25 portfolios.

Portfolio Returns
We now explore the return performance of the 25 portfolios formed based on size and PB
ratio. We create five new portfolios as Value Minus Growth (VMG) within each size quintile.
The new VMG portfolios represent the size-adjusted value premium as they are formed
from the difference between the return of the value portfolio less the return of the growth
portfolio within each size quintile.

Results and Discussion

Table 1 provides summarized information of the mean number of companies, market
capitalization and PB ratios of the 25 size-PB portfolios when they are held for the following
three months. This means, the returns are value-weighted buy-and-hold strategy. Panel A
reports the mean number of companies within each of the 25 portfolios. These results
clearly demonstrate that growth stocks are over-represented in the large size quintile, with
28% of stocks in largest size quintile classified as growth and 12% as value. As we move
down the size portfolio, we find most of the firms are classified as value. 52% of micro
firms are classified as value, whereas only 5% of them are classified as growth, i.e., value
stocks are on average smaller than growth stocks. This finding is consistent with prior
overseas evidence (Fama and French, 1993; Elfakhani et al., 1998; and Bagella et al., 2000).

Does Value Premium Exist in India? 57

 The result that value stocks are on average smaller than growth stocks is confirmed by
Panels B and C which report the percentage of total market capitalization and mean market
capitalization of the portfolios respectively. Panel B indicates that the growth stocks in large
size portfolio comprise 24%, while the value stocks comprise only 5%. Panel C indicates
that the mean market capitalization of the growth portfolio in the large quintile is 456,496.57
mn, while the value portfolio has a lower mean market capitalization of 249,118.73 mn.
Panel D of Table 1 reports the mean PB ratio of each portfolio. The mean PB ratio is
fairly consistent across the five size quintiles within each PB quintile. For instance, the high
growth portfolio across all size sorts has an average PB ratio of 17.26, with the largest size
growth portfolio exhibiting a mean PB ratio of 14.99 and the smallest size growth portfolio
(micro) exhibiting a price-to-book ratio of 26.75. Next three quintiles are much more
consistent. The only exception to the general rule of consistent PB ratios is the value
classification, where the average PB ratio across all sizes is 0.09, with the largest size
value portfolio exhibiting a price-to-book ratio of 1.21, while Portfolio 2 has a PB ratio
of 0.69.

Table 1: Characteristics of Size and Price-to-Book Sorted Portfolios

Growth 2 3 4 Value Total
Panel A: No. of Companies
Large 12 9 9 7 5 42
Portfolio 2 16 13 10 8 8 55
Portfolio 3 7 9 9 10 8 43
Portfolio 4 4 7 10 11 14 46
Micro 5 8 12 21 49 95
Total 44 46 50 57 84 281
Panel B: Percentage of Total Market Capitalization (in %)
Large 23.91 14.15 16.86 15.21 4.63 75
Portfolio 2 4.63 3.45 2.63 2.14 2.08 15
Portfolio 3 0.81 1.09 1.05 1.15 0.87 5
Portfolio 4 0.25 0.48 0.63 0.72 0.89 3
Micro 0.14 0.24 0.34 0.58 1.08 2
Total 30 19 22 20 10
Panel C: Mean Market Capitalization (in mn)
Large 456,496.57 405,931.09 475,865.34 557,499.70 249,118.73
Portfolio 2 70,666.26 65,217.59 63,998.30 63,888.86 64,581.54
Portfolio 3 27,622.90 28,287.29 27,506.89 27,094.30 27,168.88
Portfolio 4 16,044.61 15,877.04 16,051.58 16,102.09 15,480.04
Micro 5,995.02 7,317.37 7,075.06 6,696.62 6,077.40

58 The IUP Journal of Applied Economics, Vol. XIV, No. 2, 2015

 Table 1 (Cont.)
Growth 2 3 4 Value Total
Panel D: Mean PB Ratios
Large 14.99 4.85 3.20 2.11 1.21
Portfolio 2 14.01 4.83 3.19 2.14 0.69
Portfolio 3 15.05 4.77 3.17 2.12 0.04
Portfolio 4 15.50 4.72 3.12 2.14 0.08
Micro 26.75 4.82 3.20 2.07 0.19

Table 2 presents the one period (one quarter) ahead mean monthly returns, standard
deviation of monthly returns and t-statistics of each of the 25 size-PB portfolios and five
VMG portfolios. It is observed from Table 2 that there are no significant differences in
returns of any of the size quintile, while moving from growth to value portfolios. The
t-statistic in Panel A shows whether the VMG portfolio has a mean return significantly
different from zero across all size quintiles. It clearly indicates that there are no significant
differences between the mean monthly returns for any of the size quintiles. Negative value
premium has been found in all portfolios irrespective of size quintile which is very much
unexpected and contrary to the results found in other countries. However, all of those
premiums across the size quintiles are found to be negligible and statistically insignificant.
Panel B of Table 2 depicts the standard deviation of returns on each of the portfolios.
These results show that the five PB portfolios have more or less similar volatility in returns
within each size quintile. However, as size declines the standard deviation increases across
all PB portfolios. So, there is a strong evidence of general pattern of smaller size portfolios
having higher volatility in returns. Among the various other arguments for this judgment is
the observation that small stocks have a lower price per share. This implies that small stocks
are more likely to exhibit higher volatility because a small variation in price leads to a higher
percentage change.

Table 2: Return Characteristics of Size and Price-to-Book Sorted Portfolios

During the Period June 2003 to September 2013
(When Portfolios are Rebalanced Quarterly and Held for One Quarter)

Growth 2 3 4 Value VMG t-Statistic

Panel A : Mean Monthly Returns (in %)
Large 0.00 0.63 0.67 1.05 0.12 0.12 0.20
Portfolio 2 1.68 0.74 1.31 1.30 0.87 0.81 1.45
Portfolio 3 0.98 1.70 0.35 0.87 0.54 0.44 0.64
Portfolio 4 1.85 1.92 1.45 0.65 0.77 1.08 1.30
Micro 2.16 1.49 1.96 1.82 2.10 0.06 0.08

Does Value Premium Exist in India? 59

 Table 2 (Cont.)
Growth 2 3 4 Value VMG t-Statistic
Panel B : Standard Deviation (in %)
Large 2.47 2.40 2.37 2.60 2.82
Portfolio 2 2.34 2.47 2.44 2.61 2.60
Portfolio 3 2.60 2.47 2.52 2.69 2.80
Portfolio 4 2.77 2.46 2.56 2.72 2.81
Micro 3.21 2.79 2.66 2.82 3.06

Tables 3 to 6 depict the two periods (half year), three periods (three quarters), four
periods (1 year) and eight periods (2 years) ahead mean monthly return of the stocks in six
different portfolios including VMG portfolio. Results similar to that of Table 2 have been
found in Panel A as well as in Panel B of the Tables 3 to 6. All of the value premiums across
the size quintiles of different time periods are found to be negligible and statistically insignificant.
Moreover, in all cases, standard deviation of returns are found to be similar within each size
quintile. However, they are increasing across all the PB portfolios.
In summary, the results indicate that there is no evidence of presence of value premium
in India in short or long run once we control for size effects. Hence, it is possible that there
is presence of an anomaly in this issue and the stock market of India operates differently as
compared to those of other countries.

Table 3: Return Characteristics of Size and Price-to-Book Sorted Portfolios

During the Period June 2003 to September 2013
(When Portfolios are Rebalanced Quarterly and Held for Six Months)

Growth 2 3 4 Value VMG t-Statistic

Panel A : Mean Monthly Returns (in %)
Large 1.01 2.58 1.82 1.87 0.11 1.12 1.26
Portfolio 2 1.92 0.86 1.63 2.43 2.04 0.13 0.13
Portfolio 3 2.13 2.08 1.62 2.26 1.87 0.26 0.23
Portfolio 4 3.48 2.63 1.84 1.42 3.06 0.43 0.26
Micro 2.54 2.94 3.34 2.48 3.63 1.09 0.95
Panel B : Standard Deviation (in %)
Large 2.35 2.30 2.34 2.43 2.76
Portfolio 2 2.28 2.41 2.42 2.54 2.58
Portfolio 3 2.55 2.36 2.55 2.60 2.70
Portfolio 4 2.69 2.41 2.43 2.64 2.74
Micro 2.89 2.78 2.58 2.77 2.91

60 The IUP Journal of Applied Economics, Vol. XIV, No. 2, 2015

 Table 4: Return Characteristics of Size and Price-to-Book Sorted Portfolios
During the Period June 2003 to September 2013
(When Portfolios are Rebalanced Quarterly and Held for Nine Months)

Growth 2 3 4 Value VMG t-Statistic

Panel A : Mean Monthly Returns (in %)
Large 0.43 0.04 0.49 0.34 0.13 0.29 0.47
Portfolio 2 1.00 0.02 0.16 1.19 0.62 0.38 0.47
Portfolio 3 0.80 1.72 0.11 0.05 0.06 0.73 0.99
Portfolio 4 0.82 0.60 1.16 0.64 0.01 0.81 0.96
Micro 3.52 1.78 1.94 0.91 1.73 1.78 1.94
Panel B : Standard Deviation (in %)
Large 2.40 2.41 2.40 2.45 2.61
Portfolio 2 2.22 2.32 2.46 2.37 2.63
Portfolio 3 2.55 2.41 2.61 2.60 2.67
Portfolio 4 2.73 2.47 2.33 2.58 2.72
Micro 2.84 2.73 2.54 2.72 2.87

Table 5: Return Characteristics of Size and Price-to-Book Sorted Portfolios

During the Period June 2003 to September 2013
(When Portfolios are Rebalanced Quarterly and Held for One Year)

Growth 2 3 4 Value VMG t-Statistic

Panel A : Mean Monthly Returns (in %)
Large 0.25 0.32 0.11 0.71 0.31 0.06 0.09
Portfolio 2 0.83 0.55 0.93 1.41 0.20 0.63 1.15
Portfolio 3 1.29 1.13 0.09 0.25 0.27 1.03 1.34
Portfolio 4 0.96 0.38 1.33 0.45 0.06 0.90 1.08
Micro 1.45 2.73 2.83 1.94 1.98 0.53 0.63
Panel B : Standard Deviation (in %)
Large 2.33 2.29 2.34 2.57 2.66
Portfolio 2 2.25 2.31 2.44 2.41 2.55
Portfolio 3 2.51 2.32 2.53 2.66 2.69
Portfolio 4 2.76 2.47 2.35 2.58 2.70
Micro 2.77 2.59 2.56 2.67 2.85

Does Value Premium Exist in India? 61

 Table 6: Return Characteristics of Size and Price-to-Book Sorted Portfolios
During the Period June 2003 to September 2013
(When Portfolios are Rebalanced Quarterly and Held for Two Years)

Growth 2 3 4 Value VMG t-Statistic

Panel A : Mean Monthly Returns (in %)

Large 1.12 0.04 0.77 0.20 0.08 1.03 1.20

Portfolio 2 0.59 0.55 1.42 0.93 0.35 0.94 0.86

Portfolio 3 0.79 1.41 0.29 0.51 0.53 1.32 1.38

Portfolio 4 0.19 0.97 0.92 0.44 0.21 0.40 0.32

Micro 0.51 1.08 0.65 1.05 1.07 1.58 1.47

Panel B : Standard Deviation (in %)

Large 2.29 2.36 2.31 2.45 2.56

Portfolio 2 2.26 2.31 2.38 2.31 2.57

Portfolio 3 2.40 2.31 2.42 2.74 2.69

Portfolio 4 2.66 2.28 2.33 2.53 2.62

Micro 2.78 2.50 2.61 2.58 2.77

Conclusion
Studies of overseas markets, particularly those of the US, have documented the significant
influence of book-to-market effects on equity returns. Researches in Indian market fail to
document similar findings. Moreover, no robustness checking is performed in those studies.
This study remedies these problems by examining the presence of value effect while employing
a buy-and-hold strategy for a short span of one quarter to a relatively longer span of two
years over the 10-year period from June 2003 to September 2013.
Using two independent sorts (portfolios are sorted according to their size and PB ratios),
no evidence of value effect is found across portfolios in Indian market. So, there is no
significant difference in returns between high and low price-to-book portfolios after controlling
for size.
This evidence is quite important for a number of reasons. First, the findings appear to
settle the question in dispute as to whether the value premium is present in the Indian market.
Second, the findings expose variability in standard deviations across portfolios. This has
implications for the economic significance of trading strategies based on value philosophies.
Finally, the use of a clean dataset avoids any criticism of data snooping and therefore the
study improves the comparative evidences across international equity markets.

62 The IUP Journal of Applied Economics, Vol. XIV, No. 2, 2015

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64 The IUP Journal of Applied Economics, Vol. XIV, No. 2, 2015

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