Working Paper: NBER ID: w1462
Authors: James M. Poterba; Lawrence H. Summers
Abstract: This paper examines the potential influence of changing volatility in stock market prices on the level of stock market prices. It demonstrates that volatility is only weakly serially correlated, implying that shocks to volatility do not persist. These shocks can therefore have only a small impact on stockmarket prices, since changes in volatility affect expected required rates of return for relatively short intervals. These findings lead us to be skeptical of recent claims that the stock market's poor performance during the 1970's can be explained by volatility-induced increases in risk premia.
Keywords: volatility; stock market; risk premium; asset prices
JEL Codes: G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Changes in stock market volatility (G17) | Stock market prices (G10) |
| Volatility shocks (E32) | Changes in expected required rates of return (G19) |
| Volatility (E32) | Market value (D46) |
| Volatility-induced increases in risk premia (G17) | Stock market performance in the 1970s (G10) |
| Fluctuations in risk premia associated with changes in return volatility (G17) | Variation in stock prices (G17) |
| Volatility (E32) | Actual market volatility (G17) |
| Implied volatilities in option premia (G13) | Actual market volatility (G17) |