Samuelson’s Dictum and the Stock Market
SAMUELSON’S DICTUM AND THE STOCK MARKET
BY JEEMAN JUNG and ROBERT J. SHILLER
COWLES FOUNDATION PAPER NO. 1183
COWLES FOUNDATION FOR RESEARCH IN ECONOMICS YALE UNIVERSITY Box 208281 New Haven, Connecticut 06520-8281 2006 http://cowles.econ.yale.edu/
SAMUELSON’S DICTUM AND THE STOCK MARKET
JEEMAN JUNG and ROBERT J. SHILLER*
Samuelson has offered the dictum that the stock market is ‘‘micro efficient’’ but ‘‘macro inefficient.’’ That is, the efficient markets hypothesis works much better for individual stocks than it does for the aggregate stock market. In this article, we review a strand of evidence in recent literature that supports Samuelson’s dictum and present one simple test, based on a regression and a simple scatter diagram, that vividly illustrates the truth in Samuelson’s dictum for the U.S. stock market data since 1926. (JEL G14)
I. INTRODUCTION
Paul A. Samuelson has argued that one would expect that the efficient markets hypothesis should work better for individual stocks than for the stock market as a whole:
Modern markets show considerable micro efficiency (for the reason that the minority who spot aberrations from micro efficiency can make money from those occurrences and, in doing so, they tend to wipe out any persistent inefficiencies). In no contradiction to the previous sentence, I had hypothesized considerable macro inefficiency, in the sense of long waves in the time series of aggregate indexes of security prices below and above various definitions of fundamental values.1
We shall see in this article that there is now substantial evidence supporting Samuelson’s dictum where market inefficiency is defined as predictability of future (excess) returns. We will also present a new test and scatter diagram that clarifies the truth in this dictum. Samuelson’s dictum is plausible if there is much more information available to the market about future changes in fundamentals (the
*We are indebted to John Y. Campbell, Erik Hjalmarsson, Paul A.
BY JEEMAN JUNG and ROBERT J. SHILLER
COWLES FOUNDATION PAPER NO. 1183
COWLES FOUNDATION FOR RESEARCH IN ECONOMICS YALE UNIVERSITY Box 208281 New Haven, Connecticut 06520-8281 2006 http://cowles.econ.yale.edu/
SAMUELSON’S DICTUM AND THE STOCK MARKET
JEEMAN JUNG and ROBERT J. SHILLER*
Samuelson has offered the dictum that the stock market is ‘‘micro efficient’’ but ‘‘macro inefficient.’’ That is, the efficient markets hypothesis works much better for individual stocks than it does for the aggregate stock market. In this article, we review a strand of evidence in recent literature that supports Samuelson’s dictum and present one simple test, based on a regression and a simple scatter diagram, that vividly illustrates the truth in Samuelson’s dictum for the U.S. stock market data since 1926. (JEL G14)
I. INTRODUCTION
Paul A. Samuelson has argued that one would expect that the efficient markets hypothesis should work better for individual stocks than for the stock market as a whole:
Modern markets show considerable micro efficiency (for the reason that the minority who spot aberrations from micro efficiency can make money from those occurrences and, in doing so, they tend to wipe out any persistent inefficiencies). In no contradiction to the previous sentence, I had hypothesized considerable macro inefficiency, in the sense of long waves in the time series of aggregate indexes of security prices below and above various definitions of fundamental values.1
We shall see in this article that there is now substantial evidence supporting Samuelson’s dictum where market inefficiency is defined as predictability of future (excess) returns. We will also present a new test and scatter diagram that clarifies the truth in this dictum. Samuelson’s dictum is plausible if there is much more information available to the market about future changes in fundamentals (the
*We are indebted to John Y. Campbell, Erik Hjalmarsson, Paul A.
References: Belsley, D. A., E. Kuh, and R. E. Welsch. Regression Diagnostics: Identifying Influential Data and Sources of Collinearity. New York: Wiley, 1980. Campbell, J. Y. ‘‘A Variance Decomposition for Stock Returns.’’ Economic Journal, 101, 1991, 157–79. Campbell, J. Y., and R. J. Shiller. ‘‘The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors.’’ Review of Financial Studies, 1, 1988a, 195–228. ———. ‘‘Stock Prices, Earnings, and Expected Dividends.’’ Journal of Finance, 43, 1988b, 661–76. ———. ‘‘Valuation Ratios and the Long-Run Stock Market Outlook.’’ Journal of Portfolio Management, Winter 1998, 11–26. ———. ‘‘Valuation Ratios and the Long-Run Stock Market Outlook: An Update.’’ NBER Working Paper No. 8221, 2001. (Forthcoming in Advances in Behavioral Finance II, edited by Richard Thaler. New York: Sage Foundation, 2003.) 11. Jung (2002) finds using variance and covariance ratio tests that individual stock returns show quite different mean reversion characteristics than do the returns on the portfolio of them.