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Endogenous dispersion and volatility in stock returns

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  • Cun, Wukuang
  • Xia, Junjie

Abstract

Measures of stock market volatility, such as the cross-sectional dispersion of firm-level stock returns and the time-series volatility of market returns, fluctuate countercyclically. While this phenomenon is often used as evidence that exogenous rises in uncertainty lead to economic recessions, we show that first-moment productivity shocks can cause countercyclical fluctuations in stock market volatility. We study a dynamic model with costly state verification, allowing for ex-ante monitoring that can credibly compel borrowers to reveal true investment outcomes to lenders, thereby reducing information asymmetry. Interpreting these financial contracts as external equities, we show that the calibrated model, with only first-moment shocks, can generate cyclical fluctuations in equity return volatility and financial conditions, with correlation coefficients between pairs of these measures quantitatively in line with the data.

Suggested Citation

  • Cun, Wukuang & Xia, Junjie, 2026. "Endogenous dispersion and volatility in stock returns," Journal of Economic Dynamics and Control, Elsevier, vol. 187(C).
    • Handle: RePEc:eee:dyncon:v:187:y:2026:i:c:s0165188926000667
    DOI: 10.1016/j.jedc.2026.105320
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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G3 - Financial Economics - - Corporate Finance and Governance

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