Higher risk that is not rewarded with higher returns.
Investors should strive to avoid unrewarded risk in their selection process, as this is not compensated for with any kind of payoff in the form of higher returns.
An example of taking unrewarded risk is to buy cheap stocks of companies with a higher risk of default. It may appear that these are value stocks that enable the investor to benefit from a value premium, but our research shows* such stocks are very risky. Investors do not benefit from the value premium because they are not compensated for this higher level of risk with a higher return.
* W. de Groot and J. Huij: ‘Is the Value Premium Really a Compensation for Distress Risk?’, 2011
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