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Risk, Inflation, and the Stock Market

  • Pindyck, Robert S

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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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. 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.
  2. Zvi Bodie & Alex Kane & Robert McDonald, 1985. "Inflation and the Role of Bonds in Investor Portfolios," NBER Chapters, in: Corporate Capital Structures in the United States, pages 167-196 National Bureau of Economic Research, Inc.
  3. Fama, Eugene F. & Schwert, G. William, 1977. "Asset returns and inflation," Journal of Financial Economics, Elsevier, vol. 5(2), pages 115-146, November.
  4. 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.
  5. 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.
  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. Bodie, Zvi, 1976. "Common Stocks as a Hedge against Inflation," Journal of Finance, American Finance Association, vol. 31(2), pages 459-70, May.
  8. 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.
  9. Feldstein, Martin, 1982. "Inflation and the Stock Market: Reply," American Economic Review, American Economic Association, vol. 72(1), pages 243-46, March.
  10. Martin Feldstein & James M. Poterba & Louis Dicks-Mireaux, 1981. "The Effective Tax Rate and the Pretax Rate of Return," NBER Working Papers 0740, National Bureau of Economic Research, Inc.
  11. Martin Feldstein, 1979. "Inflation, Tax Rules, and the Stock Market," NBER Working Papers 0403, National Bureau of Economic Research, Inc.
  12. Parks, Richard W, 1978. "Inflation and Relative Price Variability," Journal of Political Economy, University of Chicago Press, vol. 86(1), pages 79-95, February.
  13. 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.
  14. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
  15. Feldstein, Martin, 1980. "Inflation and the Stock Market," American Economic Review, American Economic Association, vol. 70(5), pages 839-47, December.
  16. Friend, Irwin & Hasbrouck, Joel, 1982. "Inflation and the Stock Market: Comment," American Economic Review, American Economic Association, vol. 72(1), pages 237-42, March.
  17. 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.
  18. 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.
  19. 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.
  20. 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.
  21. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, vol. 83(3), pages 509-34, June.
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