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 …show more content…

Applying this model to the aggregate U.S. stock market 1871–1987, they concluded that only about 7% of the variance of annual stock market returns can be justified in terms of new information about future dividends. Vuolteenaho (2002) extended the Campbell– Shiller framework in such a way that it could be used to produce a decomposition of unexpected excess returns of a firm into a component due to information about future cash flows of the firm (what we will call the efficient market component) and a component due to information about future returns (what we will call the inefficient market component of returns). Vuolteenaho studied 36,791 firmyears of data for the United States 1954–96. He found, based on a vector-autoregressive

analysis, that about 75% of the variance of (unexpected) annual firm stock excess returns can be justified in terms of the efficient market component. Vuolteenaho also estimated the standard deviation of the ‘‘atypical discount’’ (the difference between the log stock price and the log value that is justified by fundamentals as he measures them) to be about 25%. Vuolteenaho concludes that even though he found that most of the variance of returns can be justified in terms of fundamentals, the inefficient component of stock price variation that