Value investing in emerging markets : local macroeconomic risk and extrapolation

Our results confirm the profitability of value investing at the country level in emerging markets. A
portfolio of countries with low price-to-book ratios significantly outperforms a portfolio of high
price-to-book countries. Global risk factors cannot explain this outperformance. Next we measure
a number of macroeconomic variables of the countries in the long and short value portfolios, as a
proxy for local risk factors. We find that the countries in the low price-to-book portfolio on
average have significantly lower economic growth, higher growth volatility, higher inflation, more
overvalued currencies and more volatile currencies, compared to the high price-to-book portfolio.
After portfolio formation, the difference in economic fundamentals between the high and low
price-to-book portfolios decreases significantly, which indicates that investors might be
extrapolating past economic trends too far into the future.

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