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Risk, Inflation, and the Stock Market

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  • Pindyck, Robert S

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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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 74 (1984)
Issue (Month): 3 (June)
Pages: 335-51

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Handle: RePEc:aea:aecrev:v:74:y:1984:i:3:p:335-51

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  1. Fama, Eugene F. & Schwert, G. William, 1977. "Asset returns and inflation," Journal of Financial Economics, Elsevier, vol. 5(2), pages 115-146, November.
  2. Bodie, Zvi, 1976. "Common Stocks as a Hedge against Inflation," Journal of Finance, American Finance Association, vol. 31(2), pages 459-70, May.
  3. Parks, Richard W, 1978. "Inflation and Relative Price Variability," Journal of Political Economy, University of Chicago Press, vol. 86(1), pages 79-95, February.
  4. Nelson, Charles R, 1976. "Inflation and Rates of Return on Common Stocks," Journal of Finance, American Finance Association, vol. 31(2), pages 471-83, May.
  5. Hendershott, Patric H, 1981. "The Decline in Aggregate Share Values: Taxation, Valuation Errors, Risk and Profitability," American Economic Review, American Economic Association, vol. 71(5), pages 909-22, December.
  6. Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, vol. 65(5), pages 900-922, December.
  7. Feldstein, Martin & Dicks-Mireaux, Louis & Poterba, James, 1983. "The effective tax rate and the pretax rate of return," Journal of Public Economics, Elsevier, vol. 21(2), pages 129-158, July.
  8. Feldstein, Martin, 1980. "Inflation and the Stock Market," American Economic Review, American Economic Association, vol. 70(5), pages 839-47, December.
  9. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Martin Feldstein & Lawrence H. Summers, 1979. "Inflation and the Taxation of Capital Income in the Corporate Sector," NBER Working Papers 0312, National Bureau of Economic Research, Inc.
  11. Grossman, Sanford J & Shiller, Robert J, 1981. "The Determinants of the Variability of Stock Market Prices," American Economic Review, American Economic Association, vol. 71(2), pages 222-27, May.
  12. Zvi Bodie & Alex Kane & Robert L. McDonald, 1985. "Inflation and the Role of Bonds in Investor Portfolios," NBER Working Papers 1091, National Bureau of Economic Research, Inc.
  13. Martin Feldstein, 1983. "Inflation, Tax Rules, and the Stock Market," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 199-220 National Bureau of Economic Research, Inc.
  14. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
  15. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, vol. 83(3), pages 509-34, June.
  16. Holland, Daniel M & Myers, Stewart C, 1980. "Profitability and Capital Costs for Manufacturing Corporations and All Nonfinancial Corporations," American Economic Review, American Economic Association, vol. 70(2), pages 320-25, May.
  17. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
  18. Malkiel, Burton G, 1979. "The Capital Formation Problem in the United States," Journal of Finance, American Finance Association, vol. 34(2), pages 291-306, May.
  19. Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, vol. 65(3), pages 269-82, June.
  20. Friend, Irwin & Hasbrouck, Joel, 1982. "Inflation and the Stock Market: Comment," American Economic Review, American Economic Association, vol. 72(1), pages 237-42, March.
  21. Feldstein, Martin, 1982. "Inflation and the Stock Market: Reply," American Economic Review, American Economic Association, vol. 72(1), pages 243-46, March.
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