The Variability of the Market Factor of the New York Stock Exchange

Author(s): R. R. Officer
Source: The Journal of Business , Jul., 1973, Vol. 46, No. 3 (Jul., 1973), pp. 434-453
Published by: The University of Chicago Press

Stable URL: https://www.jstor.org/stable/2351391

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 R. R. Officer*

The Variability of the Market Factor of the

New York Stock Exchanget

A decline in the variability of the market factor1 over the period 1926
to 1960 has been noted in studies by King, Blume, and Fisher and Lorie.2
A number of hypotheses have been advanced to explain this decline in
the variability of returns. The formation of the Securities and Exchange
Commission (SEC) by the Securities Act of 1933 has been suggested
as an important cause. Another suggested cause is the effect of margin
requirements which were first instituted in 1934. Still another is the fact
that the number of stocks listed on the New York Stock Exchange
(NYSE) has more than doubled since 1926; thus we might expect the
market factor to reflect a more diversified range of activities, and this
could account for a decline in its variability. Finally, another hypothesis
is that since the market factor reflects general economic conditions, any
decline in its variability might be related to a decline in business fluctua-
tions. This study examines these hypotheses.
The major finding of the study, obtained from an examination of
market-factor variability over the period of 1897 to 1969, is that the
decline in variability observed by other studies is better described as a
return to the "normal" level of variability that existed before the great
depression of the 1930s.

THE BEHAVIOR OF THE 1 -YEAR

STANDARD DEVIATION OF THE

MARKET FACTOR: 1897-1 969

Figure 1 shows the behavior of the 1-year standard deviation of the
monthly market factor, estimated as a monthly moving series, for the
period February 1897-June 1969. The figure indicates that the variability
of the market factor before the 1930s is similar to that after about 1942.

* University of Queensland, Australia.

t The author acknowledges helpful comments and criticism of this study by
E. F. Fama, M. H. Miller, C. R. Nelson, and H. V. Roberts. The work was con-
ducted while the author was at the Graduate School of Business, University of
Chicago.
1. In this study the market factor can be thought of as an index of the re-
turns to all stocks on the New York Stock Exchange; it represents common move-
ments in all stocks.
2. B. F. King, "Market and Industry Factors in Stock Price Behavior,"
Joutrnal of Bu,siniess 39 (January 1966): 139-90; M. E. Blume, "The Assessment
of Portfolio Performance: An Application of Portfolio Theory" (Ph.D. diss.,
University of Chicago, 1968); and L. Fisher and J. Lorie, "Some Studies of Vari-
ability of Returns on Investments in Common Stocks," Joutrnial of Buisiness 43
(April 1970): 99-134.

434

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435 Variability of the Market Factor

It is apparent that the decline in variability observed by other studies3

is better described as a return to normal levels of variability after a
period of abnormal behavior in the 1930s.
The series was obtained by estimating the standard deviation of the
market factor for the first 12 months of data, then the first month was
dropped and the thirteenth month added to obtain a new estimate. Each
estimate was centered at its approximate midpoint, for example, 6
months. This procedure was followed until the last month of data was
included in an estimate, so that the last estimate of the standard devia-
tion, containing 12 observations of the market factor, covered the
period May 1968-June 1969.
Other measures of the variability of the market factor, in particu-
lar the 1-year mean absolute deviation and the fractile range 0.28-0.72,
were estimated in a similar manner. A close linear relationship was
found between the time-series behavior of the three measures of vari-
ability.4
A number of indexes were used to represent the market factor.
From February 1897 until July 1914 the 12 stock Dow-Jones Industrial
Average (hereafter Dow-Jones) was used as a surrogate for the market
factor. The NYSE was closed from August 1, 1914 until December 12,
1914. The 20-stock Dow-Jones was used from January 1915 until Janu-
ary 1926, the Fisher Arithmetic Index (hereafter Fisher) was used from
February 1926 until June 1968,5 and an arithmetic index was constructed
from the Scholes Daily Price File for the period July 1968 until June
1969.6
Clearly, it would have been desirable to use the same index over
the whole period, but there is no single index which covers such a long
period. Further, it is considered that the use of several indexes instead
of one will not alter the general pattern of the series depicted in figure 1.
For example, the linear relationship between the 1-year standard devia-
tion of the 20-stock Dow-Jones7 and the 1-year standard deviation of
the Fisher had an r2 =.96 over the period 1926-68. Nonetheless, there
are two specific biases, each operating in opposite directions, resulting
from the use of several indexes. A regression of the 20-stock Dow-Jones
on the Fisher for the period over which the indexes overlapped, February
1926-September 1928, indicated a slope coefficient of about .88 using
the Fisher as the independent variable. Such a result suggests a down-

3. See n. 2 above.
4. This was indicated by an r2 of about .8 between the standard deviation
and the fractile range 0.28-0.72 and 0.9 between the standard deviation and the
mean absolute deviation. Also, justification for the use of the standard deviation
as a measure of variability is provided by R. R. Officer, "The Distribution of
Stock Returns," Journal of American Statistical Association 67 (December 1972):
807-12.
5. The index is described in L. Fisher, "Some New Stock Market Indexes,"
Joutrnial of Butsiniess 39 (January 1966): 191-225.
6. This file was made available by Wells Fargo Bank, San Francisco.
7. That is, the stocks making up the index as of January 1926.

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 436 The Journal of Business

z.

UJ

U-
C

(n

~cc

a:.

1/ 897 590 /13 1/1922 5/1930 9/1938 1/1907 5/1956 9/i964 1/Lf9
TIME

FIG. I.- The behavior of the 1-year standard deviation of the monthly
returns of the market factor.

ward bias in the standard deviation of the Dow-Jones relative to that of

the Fisher. ButE the fewer stocks in the Dow-Jones can be expected to
give a bias in the opposite direction. It is not suggested that these biases
are of equal magnitude, but it is suggested that they are unimportant
relative to the pattern of behavior shown by the series in figure 1.
The rest of this paper is concerned with examining factors that
may have had some influence on the variability of the market factor.
Unfortunately, because of the unavailability of data it was not possible
to examine these influences as far back as 1897. In general the period
1919-69 is examined.

THE FORMATION OF THE SEC

It is popularly held that SEC has been an important cause in the decline
in the variability of the market factor since the 1930s. This view has not
gone uncontested, and the issue has been vigorously debated.8 However,
the issue still remains unsettled. The reason for this is that it is difficult
to get a measure of the degree or extent of SEC intervention into the
trading of securities and the effect of disclosure laws to satisfactorily test
the proposition. Nevertheless, the graph on figure 1 of the 1-year stan-
dard deviation of the market factor over time suggests that the lower
variability of the market factor postwar is not attributable to the SEC.
The variability of the market factor in the 1920s and before is similar to
the postwar variability, and the SEC was not formed until 1933.

8. G. J. Stigler, "Public Regulation of the Securities Markets," Jourlnal of

Business 37 (April 1964): 117-42, and "Comment," ibid. (October 1964), pp. 414-
22; I. S. Friend and E. S. Herman, "The S.E.C. through a Glass Darkly," ibid., pp.
382-405, and "Professor Stigler on Securities Regulation: A Further Comment,"
ibid., 38 (January 1965): 106-10; S. Robbins and W. Werner, "Professor Stigler
Re-visited," ibid., 37 (October 1964): 406-13.

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 437 Variability of the Market Factor

MARGIN REQUIREMENTS

As with the SEC, there are a number of people who believe that margin
requirements have played an important role in reducing the variability
of the market factor.9 But in contrast to the extent of SEC intervention
in the market we have a direct measure of margin requirements and
therefore a readily testable hypothesis.
The Securities Exchange Act of 1934 gave the Federal Reserve
Board power to place a control on the extent a trader could margin his
stock. For example, the first margin requirement invoked on October 1,
1934 was 30 percent. This meant a trader had to put up 30 percent of
the value of his stock, that is, he could borrow up to 70 percent. The
margin requirements at their date of implementation are given in table 1.

Table 1
Margin Requirements and Date of
Implementation
Margin Margin
Date (%) Date (%)
10/1/34 30* 2/20/53 50
1935 40* 1/4/55 60
4/1/36 55 4/23/55 70
11/1/37 40 1/16/58 50
2/5/45 50 8/5/58 70
7/5/45 75 10/16/58 90
1/21/46 100 7/28/60 70
2/1/47 75 7/10/62 50
3/30/49 50 7/8/68 80
1/17/51 75 7/8/68 80
5/6/70 65t

NOTE.-Figures were taken from the Annual Reports of the Board of Governors of the
Federal Reserve System.
* When margin requirements were first implemented they were based on the value of
the portfolio at any time; subsequently this was modified to the date of purchase. So the figures
for 1934 and 1935 are estimates of the average requirements at date of purchase to make it
comformable with the other figures.
t This observation was not used in the regression analysis of table 2.

If margin requirements affects variability of the market factor then

we would expect an inverse relationship between the variables-a larger
margin requirement should be reflected by a smaller standard deviation
of the market factor. The tests of the effectiveness of margin require-
ments on the 1-year standard deviation of the market factor were made
by examining the variables or transformations of them in regression
relationships.
Overall, the results suggest that margin requirements are changed
after the variability in the market factor has already started to change.
This can be seen in table 2, where the change in the 1-year standard
deviation of the market for the year before a change in the margin re-
quirement shows a closer relationship with the change in the margin

9. A number of quotations from eminent sources can be found in T. G.

Moore, "Stock Market Margin Requirements," Journal of Political Economy 70
(April 1966): 158-67.

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438 The Journal of Business

E c E0 y

C E <~~~I

4X cs,

.0~~~~~~~~~~ 4 <

4-4^ t

b b & ^

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439 Variability of the Market Factor

requirement than for the same regression but for the year following the
change in the margin requirement. It was found to be necessary to also
use in the regression the 1-year standard deviation of industrial produc-
tion to distinguish the effect of margin requirements from some general
change in business fluctuations. The use of industrial production as a
measure of business fluctuations is discussed in another section below.
The implication suggested by these results is that margin require-
ments are not a generally effective means of controlling variability of the
market factor.

THE CHANGING COMPOSITION OF

STOCKS LISTED ON THE NYSE

The number of companies listed on the NYSE has been increasing over
time. If the activities of entering companies are less similar, that is,
more heterogeneous, then the market factor (portfolio) could be ex-
pected to show a decline in variability. For example, if the early market
portfolio was dominated by steel and rail companies but the portfolio in
recent years represents a much broader spectrum of activities, then we
would expect a lower average covariability between stocks, ceteris pari-
bus, and consequently a lower level of market-factor variability.
If the changing composition of the stock market plays a role in
the return of market-factor variability to "normal" levels following the
"abnormal" 1930s, then we would expect the decline in variability to
be faster for a portfolio of stocks that reflects the change in the market
structure than for a portfolio which comprises of a continuous listing of
the same stocks.
On these grounds, four constant stock indexes were constructed,
that is, each index had a constant set of stocks over the history of the
index. The indexes represent the stock composition of the market at dif-
ferent time periods, and therefore each index had a different number of
stocks. One index covered the period February 1926-June 1968, and
the others covered progressively shorter periods, all finishing at June
1968. Estimates of the market-factor variably were obtained using the
indexes as surrogates for the market factor. If the changing composition
of the stock market effects market-factor variability, then we would ex-
pect some indication of this in the differences between estimates obtained
from the four constant stock indexes and also between these indexes and
the Fisher. A comparison of the variability for each of the indexes for
periods over which the indexes had overlapping observations showed no
substantial difference between the estimates.
The results obtained so far favor the hypothesis the economy wide
factors rather than security regulation or the change in composition of
the NYSE are mainly responsible for the pattern of market-factor vari-
ability shown in figure 1. On these grounds, the study turns to examining
the relationship between market-factor variability and business fluctu-
ations.

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440 The Journal of Business

BUSINESS FLUCTUATIONS

The Federal Reserve Board's Industrial Production Index is the

best available measure of business activity on a monthly basis. This index
covers production from manufacturing, mining, electricity, and gas in-
dustries. The index includes about 35 percent of the measures used in the
construction of real GNP. Further, the use of industrial production (IP)
can be justified on the grounds that it more closely represents the activi-
ties of the companies listed on the NYSE than other measures such as
GNP.
The examination of the relationship between the market-factor vari-
ability and business fluctuations, as reflected by the standard deviation
of industrial production relatives,10 was made for three subperiods. The
subperiods were from February 1919 until January 1929, from February
1929 until January 1944, and from February 1944 until June 1969. The
idea behind these subperiods was to get a period before the great depres-
sion, a period covering the abnormal behavior of market variability dur-
ing the 1930s, and a period representing the return to lower levels of
variability postwar. The procedure used in testing the relationship be-
tween the market factor and industrial production is described below.

Testing Procedure
One-year standard deviations of industrial production relatives were esti-
mated monthly to give a moving series for the period February 1919-
June 1969. The procedure was the same as that described above to esti-
mate the 1-year standard deviation of the market factor as a monthly
moving series. Only observations 12 months apart are independent within
each of the series. Three sets of independent observations were obtained
for each series, that is, a different starting point in each moving series
was used to get each set, so that the sets are not independent of each
other but observations within each set are independent. This procedure
was adopted to give a more complete coverage of the moving series. The
relationship between the standard deviation of the industrial production
relatives (uip) and market factor (oRf) were examined for each of the
three sets of independent observations using ordinary least-squares re-
gression for the following model: 0R^i a + Wp, + ei, i- 1, . . . , N.
The next step was to examine the relationship between monthly
relatives of industrial production and the market factor: R,i - a +
bR,p.i + ei, i - 1, . . . , N. A number of different transformations of the
variable were tried; monthly relatives were found to give the best relation-
ship. In addition, different lag structures and distributed lag models were
also used to find a direct linear relationship between the variables.

Results
The hypothesis under test is whether the two variables, the standard devi-
ation of industrial production relatives and the standard deviation of the

10. By relatives it meant proportionate change, i.e., Xt/Xt_i, in the variable.

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441 Variability of the Market Factor

Table 3
Relationship between Market-Factor Variability
and Variability in Industrial Production for
Three Time Periods
r2 F-Statistic D-W Statistic Constant Coefficient

Period 1:
1. June 1919-June 1928
(10 obs.) .205 2.059 2.040 .03619 0.4709
(.00911) (.3282)
2. November 1919-November
1928 (lOobs.) . 213 2.165 1.547 .0331 0.5619
(.0102) (.3820)
3. March 1920-March 1928
(9 obs.) .266 2.535 1.898 .0303 0.6257
(.0110) (.3930)
Period 2:
1. June 1929-June 1943
(15 obs.) . 435 9.995 1.380 .0454 2.3714
(.0254) (.7500)
2. November 1929-November
1943 (15 obs. ). .529 14.602 1.606 .0315 2.7783
(.0235) (.7270)
3. March 1929-March 1943
(15 obs.) .580 17.940 1.362 .0341 2.8665
(.0226) (.6768)
Period 3:
1. June 1944-June 1968
(25 obs.) .011 0.254 1.966 .0367 0.1464
(.0049) (.2902)
2. November 1944-Novem-
ber 1968 (25 obs.) .......000 0.005 1.800 .0382 0.4842
(.0041) (.2475)
3. March 1944-March 1968
(25 obs.) .107 2.740 1.611 .0345 0.3987
(.0042) (.2409)

market factor, are related to each other. Table 3 shows the regression
relationships between variability in business activity, measured as stan-
dard deviations of industrial production relatives, and the variability of
the market factor for the three subperiods described above. Figure 2
illustrates the relationship.
An examination of the industrial production and market-factor
series in figure 2 strongly suggests a relationship between the two vari-
ables. The general pattern is remarkably similar for the two series, apart
from a large increase in the standard deviation of industrial production
covering approximately the period 1943-46. This increase in the vari-
ability of industrial production is probably explained by wartime pro-
duction which we would not expect to radically affect the stock market.
The results from table 3 clearly indicate a relationship between the
variables during the 1930s. There is some, albeit slight, relationship in-
dicated in period 1 (the 1920s) and virtually no relationship in period 3

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442 The Journal of Business

.3

.2

MARKET FACTOR

.0

WAR YEARS
.06

.03 INDUSTRIAL PRODUCTION

.02-
.01-
.00 .

no.0 H _) MONEY

1/1919 4L/927 8/1935 12/i943 4/92 8!1g60 12/1968

FIG. 2.-The 1-year standard deviation of the market factor, industrial pro-
duction relatives and money (M2) relatives.

(1944-69). In order for any such relationship to show up clearly, the

true standard deviations would have to be changing substantially. The
evidence suggests that they were only clearly changing during the 1930s.
Moreover, in periods 1 and 3 there is probably too much noise, in the
form of omitted variables and measurement errors, to establish any clear
relationship for small movements in the standard deviations.
Similar tests to the one above were also conducted on the whole
period for 1-, 2-, 3-, 4-, 5-, and 10-year standard deviations of the mar-
ket factor and industrial production relatives. The pattern of results was
very similar for all the measures. Figure 3 shows the relationship between
the 1-, 5-, and 10-year standard deviation of the market factor; clearly
the overall pattern of each series is similar. Thus the results in table 3
and figure 2 are not just a function of the time interval ( 1 year) used to
measure variability.
There is a problem that remains to be discussed. Industrial produc-
tion is measured in real terms, whereas the market factor will have both

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443 Variability of the Market Factor

ny _

ONE YEAR SD

Cr).

FIVE YEAR SD

If) ~~~~~~~~~TEN YEAR SD

U--e

ICZ

/1919 5/19?7 9/1935 1/1914h 5/195? 9/1900o 17,19o?

TIME

FIG. 3.-The 1-, 5-, and 10-year standard deviations of monthly returns of
the market factor.

price and real components. The wholesale price index is a measure of

prices. The test for any independent contribution by price factors to
market-factor variability was made by regressing the standard deviation
of the market factor on, first, the standard deviation of industrial pro-
duction relatives and then on the standard deviation of industrial produc-
tion relatives and the standard deviation of wholesale price relatives. The
results of this stepwise procedure suggest that wholesale prices contrib-
uted very little, independently of industrial production, to explaining
market-factor variability. This does not necessarily imply that there is
little price component to stock returns. More likely it implies that price
and real production have, in the past, tended to move together.
A relationship between the amount of variability in the variables
raises the question of whether a linear relationship can be found between
the monthly relatives of industrial production and the market factor. For
each of the subperiods defined above the market factor was regressed on
industrial production relatives with industrial production leading by up
to 6 months and lagging by up to 12 months. In all, 19 separate regres-

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 444 The Journal of Business

sions were run for each subperiod. A sample of the results is given in
table 4. The results do not indicate any close relationship between the
two variables. However, in the period 2 regression where industrial pro-
duction relatives lagged (chronologically) the market factor by 1, 2, and
3 months, there is clearly an indication of some sort of relationship. And
there is just the suggestion of a similar sort of relationship in period 1.
These results suggest that it may be worthwhile to test the relation-
ship with a distributed-lag model using the market factor as the lagged
(leading) variable :11
n-1

IPt a +J w(i)Rm, t-i,

i=O

where the w(i) are the weights assigned to past values of the market
factor R,,,. The distributed-lag model used was the Almon model.12 The
Almon model constrains the weights w(i) to lie on a polynomial of de-
gree q. The polynomial is specified by taking q - 1 points along the
interval i - 1, .. ., n -1, where q - 1, . . ., n. The value of the
polynomial is estimated at these points and then for all n periods using
Lagrangiau interpolation techniques.
A sample of the models used in trying a polynomial distributed lag
are shown in table 5. These results suggest that the market factor leads
industrial production relatives in the form of a distributed lag by 3-4
months. But this relationship is only clearly established in period 2. There
is no indication of any relationship in period 3 and only a slight indica-
tion in period 1.
Overall, the results to date suggest that the abnormal behavior of
the market factor during the 1930s can be related to business activity as
reflected by industrial production. And, although no clear relationship
was shown between the variables for the other periods,13 it is reasonable
to suggest after examining figure 2 that the return to normal levels of
market variability after the war was related to business activity. Evidence
supporting this statement is given in the next section.

11. There is some confusion in the terminology here. Conventionally a lag-

ged variable in a distributed lag model is defined
n-1

LXt-b,
i=0

in fact it is really a leading variable in the terminology of business cycles, since

Xt_i values occur before (chronologically) that the dependent variable Yt.
12. S. Almon, "The Distributed Lag between Capital Appropriations and
Expenditures," Econiometrica 33 (January 1965): 178-96 (see also J. P. Cooper,
"Two Approaches to Polynomial Lags Estimation: An Expositional Note and
Comment," Report 7051, Center for Mathematical Studies in Business and Eco-
nomics, University of Chicago, 1971).
13. The failure to demonstrate a relationship in these other periods was at-
tributed to a large "noise" component relative to movements in the underlying
variables.

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445 Variability of the Market Factor

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446 The Journal of Business

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447 Variability of the Market Factor

Time-Series Behavior of Industrial Production

The time-series behavior of the industrial production relatives was ap-
proximated by a mixed autoregressive and moving average model. The
procedures used to approximate the behavior of the series are described
by Box and Jenkins.'4 A brief description of the general model is given
below:
For a stationary process, the model can be represented as (1
1Bi B- BB2- .. . - _ ,BP)zt Qo + (1 -OoB -02B2 ... qBq)at,
where Zt is the value of the original series at time t; 4i, i - 1, . I . , p
the moving average parameters. The residuals or "white noise" are at,
where t - 1 . . ., N are time periods. An example of a mixed first-order
autoregressive and moving average model is (1 - OB)zt= Qo + (1
OB)at. There will be no discussion of the properties or the problems of
estimating the parameters of these models (the reader is referred to Box
and Jenkins).15
The approach taken for estimating the appropriate models was to
examine the autocorrelograms of the original series for the three sub-
periods described above. On the basis of the pattern of correlations for
these subperiods, different models were selected. The appropriate model
was chosen on the basis of how well the residuals from the model ap-
proximated white noise.
The autocorrelations and the models selected to represent the time-
series behavior of industrial production relatives are shown in table 6.
The results clearly show that the time-series behavior of industrial pro-
duction relatives in period 2 was distinctly different from periods 1 and
3. Moreover, the models for the time-series behavior in periods 1 and 3
are almost identical. This evidence supports the hypothesis that the re-
turn to normality of the market factor after the 1930s reflected the
economy as a whole and not any action taken with the specific aim of
regulating the behavior of the stock market.
The next step is to try to look deeper into the relationship between
business fluctuations and the market factor. There are two main theories
of the cause of business fluctuations. The income-expenditure theorists in
general point to changes in investment as playing a major role in busi-
ness fluctuations, whereas the monetary theorists believe that the quantity
of money is more important than investment. We might posit that in-
dustrial production changes are a function of both variables. If this is
true, then given the results so far, we might expect the market factor to
be related to either or both investment and the quantity of money.
Unfortunately, none of the tests involving the market factor and
the value of new orders, which was used as a surrogate for investment,
showed any relationship. This is probably explained by the poor quality
of the data on new orders during the 1930s, when most of the relation-

14. G. E. P. Box and G. M. Jenkins, Time Series Analysis Forecasting and

Control (San Francisco: Holden-Day, Inc., 1970).
15. Ibid.

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448 The Journal of Business

O0 01 00 O

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. 1 1 . . . . . ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
c 0

Ct N w0 m0 0 X t O O O o 0% m0 0 S~Ct c

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449 Variability of the Market Factor

Table 7
Relationship between Market-Factor Variability
and Variability in Money (M2) Relatives for
Three Time Periods
(Measures are 1-Year Standard Deviation)
D-W
r2 F-Statistic Statistic Constant Coefficient

Period 1:
1. June 1919-June 1929
(11 obs.) ......... ...... .585 12.678 1.843 .0337 2.1770
(.0060) (0.6114)
2. November 1919-November
1929 (11 obs.) .......... .429 6.773 1.492 .0335 2.0998
(.0081) (0.8068)
3. March 1920-March 1929
(10 obs.) ............... .104 0.932 1.668 .0336 2.0494
(.0145) (2.1231)
Period 2:
1. June 1929-June 1943
(15 obs.) ............. .005 0.065 0.877 .1080 0.5242
(.0304) (2.0597)
Cochrane/Orcutt
(' .5776)* ... .. .032 0.398 1.291 .0429 1.0486
(.0177) (1.6605)
2. November 1929-November
1943 (15 obs.) ........ .. .033 0.438 1.157 .0921 1.3761
(.0301) (2.0795)
Cochrane/Orcutt
(1=.668 1)* ........ .190 2.812 1.733 .0217 3.1858
(.0188) (1.9000)
3. March 1929-March 1943
(15 obs.) .. .. .. .031 0.418 0.725 .0997 1.3880
(.0308) (2.1468)
Cochrane/Orcutt
(,8 .6296)* . . .050 0.633 1.074 .0386 1.1747
(.0170) (1.4769)
Period 3:
1. June 1944-June 1968
(25 obs.) ............. . .030 0.712 1.976 .0363 0.8087
(.0040) (0.9584)
2. November 1944-November
1968 (25 obs.) .......... .093 2.352 1.872 .0343 1.2961
(.0035) (0.8451)
3. March 1944-March 1968
(25 obs.) ............... .143 3.833 1.763 .0359 1.3265
(.0033) (0.6776)
* See n. to table 5.

ship between industrial production and the market factor was observed.
However, there were some interesting results when the quantity of money
was examined.

THE QUANTITY OF MONEY

The measure of money used in this study was M2. This measure con-
tains cash plus demand and time deposits.16 Once again the relationship

16. M. Friedman and A. Schwartz, Monetary Statistics of the U.S. (New

York: National Bureau of Economic Research, 1970).

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450 The Journal of Business

between market-factor variability, measured as the 1-year standard devi-

ations of the market factor, and variability in the quantity of money,
measured as 1-year standard deviations of M2 relatives, was examined
for three separate periods. The results and the subperiods are shown in
table 7, and the overall relationship is shown in figure 2. The three sub-
periods do not exactly correspond to those in which the variability of
industrial production and the market factor were examined. The differ-
ence is that the first subperiod in table 7, where M2 is the independent
variable, is 1 year longer than table 3, where industrial production is the
independent variable. It was found that extending this subperiod 1 year
greatly increased the relationship between the variables, possibly indicat-
ing that 1929 was a year in which M2 variability and market-factor vari-
ability were closely related. The same year does not have the same effect
when it is included in period 2. These results suggest that the relationship
between variability of percentage changes in the money supply and mar-
ket-factor variability changes between period 1 (1919-29) and period 2
(1930-43). Moreover, it will be shown below that nearly all the rela-
tionships between the standard deviation of M2 relatives and the standard
deviation of the market factor can be attributed to the large increase in
both of these variables in 1929. This is in contrast to the relationship
between the market factor and industrial production. These two variables
(or,R,u, and o-1p) show a distinct relationship throughout the 1930s, al-
though again the form of the relationship appears to have changed be-
tween period 1, this time 1919-28, and period 2, 1929-43.
Following the procedure adopted with the examination of the re-
lationship between the market factor and industrial production, the rela-
tionship between the relatives of the money supply and the market factor
were examined. This examination was conducted using a simple linear
regression model for different leads and lags in the money relatives and
also the Almon distributed-lag model. The results are not shown, but
they indicated little relationship between the relatives. If anything, there
was a slight indication that the market factor leads changes in the money
supply.

INDEPENDENT INFLUENCES OF

VARIABILITY IN THE MONEY

SUPPLY AND INDUSTRIAL

PRODUCTION ON MARKET-FACTOR

V A R I A B I L I T Y

It has been shown that the standard deviation of both money and in-
dustrial production relatives are related to the standard deviation of mar-
ket-factor relatives. The question remains of whether anything was gained
in the empirical investigation of market-factor variability by looking be-
yond just business fluctuations as indicated by industrial production. That
is, does variability in money supply contribute any more than variability
in industrial production to explaining market-factor variability? To an-

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451 Variability of the Market Factor

Table 8
Relationship between 1-Year Measures of
Standard Deviation of Market Factor
Regressed on the 1-Year Standard Deviation
of Industrial Production Relatives (IP) and
Money Supply Relatives (M2)

D-W
r2 F-Statistic Statistic Constant Coefficients

1. June 1919-
June 1928
(10 obs.):
IP .205 2.059 2.040 .0362 0.4709
(.0091) (0.3282)
M2 .113 1.019 1.724 .0363 1.7787
(.0125) (1.7620)
IP + M2. .219 0.982 2.171 .0331 0.3957 0.7408
(.0129) (0.4059) (2.0633)
2. June 1919-
June 1929
(11 obs.):
IP .. . .047 0.446 1.188 .0435 0.3230
(.0134) (0.4932)
M2 .585 12.678 1.843 .0337 2.1770
(.0060) (0.6114)

IP + M2 .611 6.272 2.29 .0277 0.2439 2.1426

(.0102) (0.3353) (0.6298)

3. November 1919-
November 1928
(10 obs.):
IP .213 2.165 1.547 .0331 0.5619
(.0102) (0.3820)
M2 .025 0.207 1.242 .0539 -1.0367
(.0159) (2.2772)
IP + M2 . 372 2.070 1.270 .0467 0.7954 -2.8844
(.0141) (0.4049) (2.1690)

4. November 1919-
November 1929
(11 obs.):
IP .035 0.327 0.945 .0430 0.3308
(.0151) (0.5784)
M2 .429 6.773 1.492 .0335 2.0998
(.0081) (0.8068)
IP+M2 .468 3.519 1.588 .0250 0.3472 2.1087
(.0138) (0.4556) (0.8263)

5. March 1920-
March 1928
(9 obs.):
IP .266 2.535 1.898 .0303 0.6257
(.0110) (0.3930)
M2 .. .136 1.105 1.682 .0306 2.3723
(.0158) (2.2570)
IP + M2 .318 1.399 1.914 .0222 0.5409 1.5346
(0.4278) (2.2653)

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452 The Journal of Business

Table 8 (Continued)
D-W
r2 F-Statistic Statistic Constant Coefficients

6. March 1920-
March 1929
(10 obs.):
IP . 163 1.552 1.654 .0361 0.4518
(.0097) (0.3627)
M2 .104 0.932 1.668 .0336 2.0494
(.0146) (2.1231)
IP + M2 .200 0.876 1.709 .0294 0.3706 1.3164
(.0154) (0.4044) (2.2890)

swer this question, the standard deviation of the market factor was re-
gressed on the standard deviation of both industrial production relatives
and money relatives together as well as independently over three sub-
intervals.
In only the first subinterval was there any substantial contribution
by the variability in the money supply to variability in the market factor.
Further, it appears that all this contribution was in 1929. Table 8 shows
the 1-yearstandard deviation of the market factor regressed on the stan-
dard deviations of industrial production relatives and money (M2)
relatives. The effect of including an e*tra observation, the 1-year stan-
dard deviation for 1929, is substantial with respect to M2; the r2 goes
from about .1 to .5. The reverse effect is noted for industrial production,
although it is not as substantial; r2 goes from approximately .2 to .05.
These results indicate a change in the relationship between industrial
production and the market factor after 1928, relative to the period
1919-28.
Remember that the dates shown in tables 7 and 8 are the center of
1-year standard deviations. It appears from tables 7 and 8 to be fairly
clear that in and around 1929 market-factor and money-supply vari-
ability show a farily close relationship, but there is little relationship in
other periods. This is not true for industrial production. The standard
deviation of industrial production relatives and the standard deviation
of the market factor were shown to be related in both periods 1 and 2.
The relationship was closer in period 2 where r2s were about .5 compared
with values of about .2 for period 1.

C O N C L U S I O N S

The apparent postwar decline in market-factor variability observed by

other studies17 was shown to be more accurately described as a return to
normal levels of variability after the abnormally high levels of the 1930s.
This fact in itself casts serious doubts on any responsibility of the SEC
for the lower levels of variability postwar. A more specific examination
was made of margin recquirements and the greater postwar diversity of

17. See n. 2 above.

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453 Variability of the Market Factor

stocks listed on the NYSE. The results indicate that neither of these
factors affects the variability of the market factor.
Evidence was presented to show that the problem of market-factor
variability can be related to business fluctuations as reflected by the vari-
ability of industrial production. Moreover, it was shown that the behavior
of industrial production was distinctly different during the 1930s than
for the two periods, 1919-28 and 1944-69, where the pattern of be-
havior was almost identical. Variability of changes in the quantity of
money could be related to market-factor variability only around 1929.

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