THE COMOVEMENT OF STOCK-PRICES

We test whether comovements of individual stock prices can be justifie d by economic fundamentals. This is a test of the present value model of security valuation with the constraint that changes in discount rat es depend only on changes in macroeconomic variables. Then, stock pric es of companies in unrelated lines of business should move together on ly in response to changes in current or expected future macroeconomic conditions. Using a latent variable model to capture unobserved expect ations, we find excess comovement of returns. We show that this excess comovement can be explained in part by company size and degree of ins titutional ownership, suggesting market segmentation.