Working Paper: NBER ID: w3106
Authors: Alan J. Marcus
Abstract: Apparent mean reversion and excess volatility in stock market prices can be reconciled with the Efficient Market Hypothesis by specifying investor preferences that give rise to the demand for portfolio insurance. Therefore, several supposed macro anomalies can be shown to be consistent with a rational market in a simple and parsimonious model of the economy. Unlike other models that have derived equilibrium mean reversion in prices, the model in this paper does not require that the production side of the economy exhibit mean reversion. It also predicts that mean reversion and excess volatility will differ substantially across subperiods.
Keywords: No keywords provided
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| demand for portfolio insurance (G52) | mean reversion (C22) |
| demand for portfolio insurance (G52) | excess volatility (G17) |
| drop in the value of risky assets (G19) | heightened demand for portfolio insurance (G52) |
| heightened demand for portfolio insurance (G52) | further price reductions (D49) |
| further price reductions (D49) | increased volatility (E32) |
| price drops (D49) | equilibrium expected market returns rise (D53) |
| price drops (D49) | observed mean reversion in stock prices (G17) |
| shocks to profitability (F69) | prices (P22) |
| shocks to profitability (F69) | demand and volatility (E41) |