On the volatility of stock prices: An exercise in quantitative theory

This paper examines the issues of volatility at the aggregate level. Rather than studying individual securities we focus on volatility utilizing aggregate stock market values and aggregate after-tax net cashflow as a ratio of national income. Our approach is in the tradition of the infinitely-lived classical growth model of Solow, where the behaviour of capital, consumption and investment are studied as shares of output. For the period 1946–1993 both the cashflows to equity and consumption as a share of national income were fairly constant. Yet there was significant movement in the value of the stock market as a share of national income. Our analysis suggests that these large movements cannot be rationalized within the context of the decentralized stochastic growth paradigm.