Question

Hello my dear students in less than one paragraph discuss if the stock market and individual stocks are more volatile today than in the past. Further discuss using the information from a study by campbell, lettau, malkiel and xu, 2001. this study looked at 9000 firms from 1962-97.they decomposed the stock into market wide, industry-wide and firm specific volatility. they found that while there were periods of increase volatility, for example during the oil crisis in the 1970s, average market volatility as measured by standard deviation has remained relatively stable over time-14% in the 1970s 16% in the 1980s and 11% in the 1990s. industry volatility has also remain stable over time. Firm specific volatility, on the other hand, more doubled from 1962 to 1997 the period of the study. The most volatile stocks moved 25% in a single day. Firm specific volatility was 65% of total volatility in 1962 and 76% in 1997. Honorable students why is it that individual stocks can be more volatile , yet not the market as a whole.A university of Nevada study at the sam time found that 100 stocks were needed to achieve complete diversification. The university of Nevada study found that the mean culprits advocating too few stocks for diversification were textbooks, professional journals and the wall street journal(which has since printed a story about this study), some individuals choose to hold portfolios with a smaller number of stocks because it is difficult to research a large number of stocks. Why are individual stocks more volatile? Why do investors think the market as a whole is more volatile?

I will be glad to get response as soon as possible. Thanks.

Answer 1

Yes, the stock market and individual stocks are more volatile today than in the past. Individual stocks tend to be more volatile than the market because of the fact that the micro risks affecting individual stocks are unique and will not affect other stocks belonging to other sectors. For instance a fall in demand for aircrafts by airline companies will hurt the stock price of GE because it manufactures and sells aviation engines. This event, however, will not impact the stock price of P&G (Procter and Gamble) in any manner. A market is made up of several stocks belonging to different industries and hence it is able to diversify the micro risk exposure of different stocks. In other words they are able to diversify the unsystematic risks of individual stocks. Despite this investors think the market as a whole is more volatile. This is a wrong belief and the basis of the belief is based on the fact that majority of investors are not able to diversify in a systematic and structured manner so as to be able to remove all the micro risks and unsystematic risks of individual stocks in the portfolio.