Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?
Read the paperopens www.nber.org in a new tab
What they found
Shiller compared the actual path of U.S. stock prices since 1871 with the price that would have been justified by the dividends that were actually paid afterward. If prices were rational forecasts of future dividends, they should be smoother than the realized dividend stream. Instead prices were five to thirteen times more volatile than the dividend evidence could explain. This 'excess volatility' finding was a founding result of behavioral finance and part of the work that earned Shiller the Nobel Prize.
What you can use
- Most market volatility is not driven by changes in fundamentals; it is driven by changing sentiment and discount rates.
- Prices can drift far from any reasonable fundamental value for years, so valuation alone is a poor timing tool.
- The volatility that makes trading possible is largely 'excess' volatility, which is why mean reversion over long horizons exists.
Caveats
The variance-bounds test was criticized on statistical grounds (small samples, non-stationarity); later work confirmed excess volatility with better methods but the size of the effect is debated. Long-horizon evidence, not a trading signal.
Tags: efficiency, volatility, behavioral, valuation
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.