Recessions and the Stock Market
62 Pages Posted: 30 Apr 2018 Last revised: 1 Feb 2020
Date Written: January 31, 2020
Why do stock prices fall more sharply than dividends around recessions? This paper provides an assessment of alternative potential economic channels suggested in the literature. One possible explanation is that stock prices fall in anticipation of low future cash flows. I find that prices and cash flows drop contemporaneously, which speaks against such a channel. Alternatively, prices drop because expected returns are rising. I find that price volatility increases substantially more than cash flow volatility during recessions, which suggests that changes in the price of risk play an important role. These results allow for a fresh empirical assessment of competing asset pricing theories.
Keywords: Consumption-Based Asset Pricing, Equity Premium, Recessions, Long Run Risk, Habits
JEL Classification: G12
Suggested Citation: Suggested Citation