Common trends and common cycles in stock markets

- We examine the role of permanent and transitory shocks.
- We consider the S&P 500, Dow Jones and the NASDAQ markets.
- We find one common trend and two common cycles.
- Permanent shocks explain the bulk of the variations in stock prices.

In this paper we examine the role of permanent and transitory shocks in explaining variations in the S&P 500, Dow Jones and the NASDAQ. Our modeling technique involves imposing both common trend and common cycle restrictions in extracting the variance decomposition of shocks. We find that: (1) the three stock price indices are characterized by a common trend and common cycle relationship; and (2) permanent shocks explain the bulk of the variations in stock prices over short horizons.