This paper proposes alternative specifications of the conditional CAPM with dynamic conditional beta and tests the models' performance in explaining the value premium for the period 1963-2011. The conditional alphas on the value-minus-growth portfolio are estimated to be economically and statistically insignificant, indicating superior performance of the conditional CAPM in explaining the value premium. The results also show that the dynamic conditional covariances of book-to-market portfolios with default spread, dividend yield, and unemployment rate are significant predictors of future returns, implying that default risk, dividend and unemployment related shocks contain systematic risks rewarded in the stock market and they can be viewed as state variables proxying for consumption and investment opportunities. Hence, the superior returns to value stocks represent compensation for bearing the risk of unfavorable shifts in the investment opportunity set along the lines of Merton's (1973) ICAPM.