There is No Excess Volatility Puzzle

We present two valuation models that we use to account for the annual data on price per share and dividends per share for the CRSP Value-Weighted Index from 1929-2023. We show that it is a simple matter to account for these data based purely on a model of variation over time in the expected ratio of dividends per share to aggregate consumption under two conditions. First, investors must receive news shocks regarding the expected ratio of dividends per share to aggregate consumption in the long run. Second, the discount rate used to evaluate the impact of this news on the current price per share must be low. We use the approach of Campbell and Shiller (1987) and Campbell and Shiller (1988) to argue that the cash flow news in our model is not a stand-in for changes in expected returns: with our model parameters, returns are not predictable and price dividend spreads and ratios predict dividend growth at model-implied magnitudes. We illustrate which parameter choices account for differences between our results and prior findings in the literature. We conclude that the answer to Shiller (1981)’s question “Do stock prices move too much to be justified by subsequent movements in dividends?” is “not necessarily”.