The Origins of Stock Market Fluctuations

Three mutually uncorrelated economic shocks that we measure empirically explain 85% of the quarterly variation in real stock market wealth since 1952. We use a model to show that they are the observable empirical counterparts to three latent primitive shocks: a total factor productivity shock, a risk aversion shock that is unrelated to aggregate consumption and labor income, and a factors share shock that shifts the rewards of production between workers and shareholders. On a quarterly basis, risk aversion shocks explain roughly 75% of variation in the log difference of stock market wealth, but the near-permanent factors share shocks plays an increasingly important role as the time horizon extends. We find that more than 100% of the increase since 1980 in the deterministically detrended log real value of the stock market, or a rise of 65%, is attributable to the cumulative effects of the factors share shock, which persistently redistributed rewards away from workers and toward shareholders over this period. Indeed, without these shocks, today's stock market would be about 10% lower than it was in 1980. By contrast, technological progress that rewards both workers and shareholders plays a smaller role in historical stock market fluctuations at all horizons. Finally, the risk aversion shocks we identify, which are uncorrelated with consumption or its second moments, largely explain the long-horizon predictability of excess stock market returns found in data. These findings are hard to reconcile with models in which time-varying risk premia arise from habits or stochastic consumption volatility.