Stock market volatility and the Great Moderation

Sean D. Campbell

No 2005-47, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: Using data on corporate profits forecasts from the Survey of Professional Forecasters, I decompose real stock returns into a fundamental news component and a return news component and analyze the effects of the Great Moderation on each. Empirically, the response of each component of real stock returns to the Great Moderation has been quite different. The volatility of fundamental news shocks has declined by 50% since the onset of the Great Moderation, suggesting a strong link between underlying fundamentals and the broader macroeconomy. Alternatively, the volatility of return news shocks has remained stable over the Great Moderation period. Since the bulk of stock market volatility is attributable to return shocks, the Great Moderation has not had a significant effect on stock return volatility. These empirical findings are shown to be consistent with Campbell and Cochrane's (1999) habit formation asset pricing model. In the face of a large decline in consumption volatility, the volatility of fundamental news shocks declines while the volatility of return shocks stagnate. Ultimately, the effect of a Great Moderation in consumption volatility on overall stock return volatility in the habit formation model is slight.

Keywords: Stock - Prices; Stock market (search for similar items in EconPapers)
Date: 2005
New Economics Papers: this item is included in nep-fin, nep-fmk and nep-sea
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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