Recessions and the Stock Market
56 Pages Posted: 30 Apr 2018 Last revised: 15 Jan 2019
Date Written: January 14, 2019
Why do stock prices fall more sharply than dividends around recessions? One explanation could be that stock prices fall in anticipation of low future cash flows. Against conventional wisdom, I do not find empirical evidence for such a channel. Alternatively, prices might drop a lot because expected future returns are high. I find that stock price volatility increases substantially more than cash flow volatility during recessions, which suggests that large changes in the price of risk play a key role. I argue that standard calibrations of theoretical asset pricing models have difficulties in explaining the stock market around recessions.
Keywords: Recessions, Stock Market, Consumption-Based Asset Pricing, Long-Run Risks, Habits, Volatility
JEL Classification: G12
Suggested Citation: Suggested Citation