Market Volatility and Investor Behavior

Abstract

It appears that speculative asset prices tend to show excess volatility relative to simple present value efficient markets models, and that prices are partly forecastable as tending to returning to mean, appropriately defined.' But what does this tell us about how speculative prices are determined? Are there in prices, and if so, how do they behave? The question has arisen recently whether there is really room for fads in speculative prices. Whether or not speculative prices are too volatile, if stock prices are highly correlated with dividends we might conclude that the movements in stock prices are driven by fundamentals, not fads. A question of longer standing is whether fads models that entail feedback from price change to price change are consistent with the observed approximate random walk price behavior, that is, rather low serial correlation of short-run price changes. We can also ask whether the feedback models are consistent with the observed relation of stock prices to dividends and earnings.

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