Risk, Inflation, and the Stock Market
Robert S. Pindyck
Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)
NBER Working Paper No. w1186
Most explanations for the decline in share values over the past two decades have focused on the concurrent increase in inflation.This paper considers an alternative explanation: a substantial increase in the riskiness of capital investments. We show that the variance of firms' real gross marginal return on capital has increased significantly, increasing the relative riskiness of investors' returns on equity, and that this can explain a large part of the market decline. We also assess the effects of increase in the mean and variance of the inflation rate, and a decline in firms' expected return on capital.
Number of Pages in PDF File: 34
Date posted: June 28, 2004