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The Stock Market and the Corporate Sector: Profit-Based Approach

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  • Anwar M. Shaikh

Abstract

This paper shows that the empirical movements of stock prices can be explained directly by fundamentals. The real stock market rate of return is shown to closely track the real incremental rate of profit of the corporate sector, with the two rates displaying similar means and standard deviations. It is argued that the two are linked by capital flows between the sectors through a process we call "turbulent arbitrage". Actual equity prices closely track the prices closely track the prices warranted by this model, and unlike the standard results, are less volatile than the warranted ones. The theoretical approach taken in this paper implies that the incremental profit rate is the required rate of return for the stock market return. The observed volatility on stock market returns and prices arises from the fact that the required rate is itself highly volatile, driven by cyclical and other short term fluctuations in aggregate demand. It is then easy to see why conventional theoretical models, which typically assume constant required rates of return (discount rates) and constant dividend growth rates, are largely unable to explain the movements in stock prices. On the other hand, since the incremental rate of profit (net of interest) is essentially the change in earnings normalized by investment, the findings of this paper accord well the experience "on the street" that stock price movements are driven by interest rates and changes in earnings.
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Suggested Citation

  • Anwar M. Shaikh, 1995. "The Stock Market and the Corporate Sector: Profit-Based Approach," Economics Working Paper Archive wp_146, Levy Economics Institute.
    • Handle: RePEc:lev:wrkpap:wp_146
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    Cited by:

    1. Lefteris Tsoulfidis, 2015. "Contending Conceptions of Competition and the Role of Regulating Capital," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 62(1), pages 15-31, March.
    2. Stravelakis, Nikos, 2014. "Financial Crisis and Economic Depression: 'Post Hoc Ego Propter Hoc'? Implications for Financial Asset Valuation and Financial Regulation," MPRA Paper 55944, University Library of Munich, Germany.
    3. John Sarich, 2006. "What do we know about the real exchange rate? A classical cost of production story," Review of Political Economy, Taylor & Francis Journals, vol. 18(4), pages 469-496.
    4. Tsoulfidis, Lefteris & Tsaliki, Persefoni, 2011. "Classical competition and regulating capital: theory and empirical evidence," MPRA Paper 51334, University Library of Munich, Germany, revised 2013.
    5. Stravelakis, Nikos, 2013. "Hilferding over Marx: A Political Economy Viewpoint of Struggles in the Left 1900-1933 and the Modern Revival," MPRA Paper 50064, University Library of Munich, Germany.
    6. Stefania Tescari & Andrea Vaona, 2014. "Regulating Rates of Return Do Gravitate in US Manufacturing!," Metroeconomica, Wiley Blackwell, vol. 65(3), pages 377-396, July.
    7. Bilgili, Faik, 2003. "Dynamic implications of fiscal policy: Crowding-out or crowding-in?," MPRA Paper 24111, University Library of Munich, Germany, revised 25 Dec 2009.
    8. Susan K. Schroeder, 2002. "A Minskian Analysis of Financial Crisis in Developing Countries," SCEPA working paper series. 2002-09, Schwartz Center for Economic Policy Analysis (SCEPA), The New School.
    9. Andrea Vaona, 2012. "Further econometric evidence on the gravitation and convergence of industrial rates of return on regulating capital," Journal of Post Keynesian Economics, Taylor & Francis Journals, vol. 35(1), pages 113-136.
    10. Tsoulfidis, Lefteris & Alexiou, Constantinos & Parthenidis, Thanasis, 2015. "Revisiting profit persistence and the stock market in Japan," Structural Change and Economic Dynamics, Elsevier, vol. 33(C), pages 10-24.
    11. Tsoulfidis, Lefteris, 2011. "Classical vs. Neoclassical Conceptions of Competition," MPRA Paper 43999, University Library of Munich, Germany, revised Oct 2012.
    12. Alexiou, Constantinos & Trachanas, Emmanouil, 2020. "Predicting post-war US recessions: A probit modelling approach," Structural Change and Economic Dynamics, Elsevier, vol. 54(C), pages 210-219.
    13. Andrea Vaona, 2010. "On the gravitation and convergence of industry incremental rates of return in OECD countries," Working Papers 03/2010, University of Verona, Department of Economics.
    14. Anwar Shaikh, 2010. "Reflexivity, path dependence, and disequilibrium dynamics," Journal of Post Keynesian Economics, Taylor & Francis Journals, vol. 33(1), pages 3-16, October.
    15. Alexiou, Constantinos & Tsaliki, Persefoni & Tsoulfidis, Lefteris, 2014. "Classical Theory of Investment. Panel Cointegration Evidence from Thirteen EU Countries," MPRA Paper 60598, University Library of Munich, Germany.
    16. Andres Blancas, 2007. "Financial Fragility Dynamics in Developing Countries, the Mexican Case," EcoMod2007 23900008, EcoMod.

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