The Persistence of Volatility and Stock Market Fluctuations
NBER Working Paper No. 1462 (Also Reprint No. r0820)
This paper examines the potential influence of changing volatility in stock market prices on the level of stock market prices. It demonstrates that volatility is only weakly serially correlated, implying that shocks to volatility do not persist. These shocks can therefore have only a small impact on stockmarket prices, since changes in volatility affect expected required rates of return for relatively short intervals. These findings lead us to be skeptical of recent claims that the stock market's poor performance during the 1970's can be explained by volatility-induced increases in risk premia.
Published: Poterba, James M. and Lawrence H. Summers, "The Persistence of Volatility and Stock Market Fluctuations," American Economic Review, December 1986, pp. 1142-1151.