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BPEA | 1989 No. 2

Economic Implications of Extraordinary Movements in Stock Prices

Benjamin M. Friedman and
BMF
Benjamin M. Friedman Harvard University
David I. Laibson
DIL
David I. Laibson
Discussants: Hyman P. Minsky
HPM
Hyman P. Minsky

1989, No. 2


MOST PEOPLE AGREE that stock prices sometimes behave in strange ways. Going beyond this simple observation typically proves more difficult. For at least the past quarter century, economists have been well aware that the variation of stock prices does not nicely match the familiar bell-shaped normal distribution. The problem is too many extreme movements. Very large increases or decreases would always be possible even if changes in stock prices were normally distributed, but they would occur only rarely. By contrast, actual stock prices rise or fall by large percentage amounts fairly often-certainly often enough to raise serious doubts that the usual normal distribution provides a useful way to think about how they vary.