A spectral perspective on excess volatility

Abstract

We perform a careful spectral analysis of the correlation structures observed in real and financial returns for a large pool of long-lived US corporations and find that financial returns are characterized by strong collective fluctuations that are absent from real returns. Once the excessive comovement is subtracted from individual financial time series, the behaviour of real and financial returns is virtually identical in both the cross-sectional and time series domains, thereby demonstrating the inherently collective nature of excessive fluctuations. Put differently, if excess volatility is to be reduced, then one would do well to inhibit excess comovement first. At any rate, the excessive behaviour in volatility and comovement should no longer be studied in isolation of each other.

Keywords:

• excess volatility
• excess comovement
• random matrix theory
• profit rate
• return on assets

JEL Classification:

• D21
• L10
• C21

Notes

¹ The average profit rate is remarkably stable over time and also reasonably similar across firms; therefore, we use the mode of the unconditional pooled profit rate distribution, .

² The ubiquity of Laplace distributions has also been observed in firm growth rates (see, e.g. Bottazzi and Secchi, 2003).

³ This material is available upon request.

Additional information

Funding

S.A. was partially funded by the EU Seventh Framework Programme (FP7/2007-2013) [grant agreement number 619255], by Universitat Jaume I under project P11B2012-27, and by the Spanish Ministry of Science and Technology under project ECO2011-23634. E.S. was partially funded by the Italian grant PRIN 2009 ‘Finitary and nonfinitary probabilistic methods in economics’ 2009H8WPX5_002 and by a start-up grant of the School of Mathematical and Physical Sciences, University of Sussex, UK.