Working Paper: NBER ID: w1186
Authors: Robert S. Pindyck
Abstract: 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.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in the variance of firms' real gross marginal return on capital (D25) | decline in stock market values (G10) |
| increase in the variance of firms' real gross marginal return on capital (D25) | increased relative riskiness of investors' returns on equity (G12) |
| increase in the variance of stock returns (G17) | decline in share values (G10) |
| interaction between inflation and the tax system (H31) | reduction of net returns from stocks (G12) |
| changes in expected returns and variance of returns (G17) | significant portion of observed decline in market values (G10) |