Keywords: Great moderation, stock market volatility, fundamental news, return news
Abstract: Using data on corporate profits forecasts from the Survey of Professional Forecasters, I decompose real stock
returns into a fundamental news component and a return news component and analyze the effects of the Great
Moderation on each. Empirically, the response of each component of real stock returns to the Great Moderation
has been quite different. The volatility of fundamental news shocks has declined by 50% since the onset of the
Great Moderation, suggesting a strong link between underlying fundamentals and the broader macroeconomy.
Alternatively, the volatility of return news shocks has remained stable over the Great Moderation period.
Since the bulk of stock market volatility is attributable to return shocks, the Great Moderation has not had
a significant effect on stock return volatility. These empirical findings are shown to be consistent with
Campbell and Cochrane's (1999) habit formation asset pricing model. In the face of a large decline in consumption
volatility, the volatility of fundamental news shocks declines while the volatility of return shocks stagnate.
Ultimately, the effect of a Great Moderation in consumption volatility on overall stock return volatility in the
habit formation model is slight.
Full paper (547 KB PDF)
Home | FEDS | List of 2005 FEDS papers
To comment on this site, please fill out our feedback form.
Last update: October 26, 2005