The Determinants of the Variability of Stock Market Prices

9 Pages Posted: 6 Jul 2004 Last revised: 23 May 2012

See all articles by Sanford J. Grossman

Sanford J. Grossman

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Robert J. Shiller

Yale University - Cowles Foundation; National Bureau of Economic Research (NBER); Yale University - International Center for Finance

Date Written: October 1980

Abstract

The most familiar interpretation for the large and unpredictable swings that characterize common stock price indices is that price changes represent the efficient discounting of "new information" It is remarkable given the popularity of this interpretation that it has never been established what this information is about. Recent work by Shiller, and Stephen LeRoy and Richard Porter, has shown evidence that the variability of stock price indices cannot be accounted for by information regarding future dividends since dividends just do not seem to vary enough to justify the price movement. These studies assume a constant discount factor. In this paper, we consider whether the variability of stock prices can be attributed to information regarding discount factors (i.e., real interest rates), which are in turn related to current and future levels of economic activity. The appropriate discount factor to be applied to dividends which are received k years from today is the marginal rate of substitution between consumption today and consumption k periods from today, We use historical data on per capita consumption from 1890-1979 to estimate the realized value of these marginal rates of substitution. Theoretically, as LeRoy and C. J. La Civita have also noted independently of us, consumption variability may induce stock price variability whose magnitude depends on the degree of risk aversion.

Suggested Citation

Grossman, Sanford J. and Shiller, Robert J., The Determinants of the Variability of Stock Market Prices (October 1980). NBER Working Paper No. w0564. Available at SSRN: https://ssrn.com/abstract=248588

Sanford J. Grossman (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Robert J. Shiller

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States
203-432-3708 (Phone)
203-432-6167 (Fax)

HOME PAGE: http://www.econ.yale.edu/~shiller/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
203-432-3708 (Phone)

Yale University - International Center for Finance ( email )

Box 208200
New Haven, CT 06520
United States
203-432-3708 (Phone)
203-432-6167 (Fax)

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