Determinants of Stock Price Volatility: A Literature Review

Abstract

The movements of stock prices highly depend on the respective economic conditions (Chen, Roll, & Ross, 1986). If the economy is performing well, it may lead to a bullish capital market, whereas its poor performance may carry out a bearish capital market. Changes in macroeconomic fundamentals impact stock prices irrespective of the firm's industry. As an example, raising the inflation rate decreases the purchasing power of the customers, leading to lower revenue for the firms (Ball & Romer, 2003). After that, the stock price may decline slightly according to the degree of inflation impact. This common phenomenon was theoretically backed by Arbitrage Pricing Model (APT) introduced by Ross (1976). The APT extends the multifactor model capturing the linear impacts of risk factors on asset returns. Macroeconomic impact has been identified as risk factor in asset return leading to price variability. Different assets have their own degree of risk premiums based on the sensitivity of the asset return on macroeconomic fundamentals. In addition to that, company-specific fundamentals also influence stock prices, like return on assets, future expected cash flows, earning power, etc. However, macroeconomic factors primarily determine the overall market performance.