Contrarian Investment and Macroeconomic Risk

It is now widely accepted that contrarian, or value investment strategies deliver superior returns. Gregory, Harris and Michou (2001) examine the performance of contrarian investment strategies in the UK and find that value strategies formed on the basis of a wide range of measures of value have delivered excess returns that are both statistically and economically significant. However, while value strategies appear to be profitable, the reason for their superior perform‐ ance is far from clear. Under the contrarian model, value strategies are profitable because they are contrarian to naïve strategies such as those that erroneously extrapolate past performance, while under the rational pricing model, value strategies are profitable because they are fundamentally riskier in some sense. In this paper, we discriminate between these two possibilities by undertaking a comprehensive investigation of the relationship between the returns to value investment strategies and various macroeconomic state variables that in a multi‐factor asset pricing model could reasonably be taken as proxies for risk. Moreover, we examine whether the returns to value strategies predict future GDP, consumption and investment growth over and above the contribution of the Fama and French (1993 and 1996) SMB, HML and market factors. While the SMB and HML factors behave in a manner consistent with the rational pricing model, we show that some value strategies in the UK are able to generate excess returns that do not seem to be related to known risk factors.