This article investigates the relationship between value premium and financial distress using a long US data set over 1927–2011. The measures of leverage and default are used as proxies for financial distress when applying a time-varying volatility methodology. The article examines the potential risk-based explanation for the source of the value premium. The empirical analysis shows that both the default premium and its volatility have positive explanatory power for the value premium and its volatility. The findings suggest a negative association between the lagged values of the default premium and the current small stocks value premium. Investigating the reasons behind this association uniquely uncovers an asymmetric correlation between returns on both value and growth stocks and default risk before and post July 1954 after a change in the monetary regime in the United States.