Why Does Stock Market Volatility Change Ouer Time? 1127 volatility is the most important variable in predicting current stock volatility Lagged bond return volatility also helps in most sample periods, and lagged short-term interest volatility contributes less. Likewise, stock volatility helps predict bond return volatility in most periods, but it rarely improves predictions of interest rate volatility. In most sample periods, short-term interest volatility helps predict bond return volatility and vice versa. Except for monthly stock volatility from 1953 to 1987, there is little evidence that inflation volatility helps to predict future asset return volatility The present value relation in(1)is forward-looking. In an efficient market speculative prices will react in anticipation of future events. Thus, it is also interesting to see whether asset return volatility helps to forecast later volatility of macroeconomic variables. Except for long-terrm bond returns from 1859 to 1987, there is no evidence that either stock or bond return volatility helps to predict inflation volatility. Perhaps this is because the major changes in inflation volatility occur during wars, and there seems to be little effect of wars on stock or bond return volatility Table IV contains tests of the incremental predictive power of 12 lags of monetary base growth volatility lEmel in a 12th-order VAR system similar to Table IiI. The relations among the measures of financial return volatility are similar to Table IlL. There is evidence that money growth volatility helps to predict the volatility of long-term bond returns from 1885 to 1919. Also, from 1885 to 1987, 1885 to 1919, and 1920 to 1952, there is evidence that money growth volatility helps to predict the volatility of stock returns measured using daily data On the other hand, from 1920 to 1952(and the sample periods that include this subperiod), both measures of stock return volatility help to predict the volatility of the base growth rate The relations between inflation or money growth volatility and the volatility of asset returns are not strong. It is surprising that. these macroeconomic measures of nominal volatility are not more closely linked with the volatility of short- and long-term bond returns B Real Macroeconomic volatility Since common stocks reflect claims on future profits of corporations, it is lausible that the volatility of real economic activity is a major determinant of stock return volatility. In the present value model (1), the volatility of future expected cash flows, as well as discount rates, changes if the volatility of real activity changes Figure 6 contains a plot of the predicted volatility of the growth rates of industrial production leil. Note that the right-hand industrial production volatility scale is about 3 smaller than the left-hand stock volatility scale. Summary statistics for these estimates are in Tables I and II. Industrial produc tion volatility was high during the mid-1930,'s, during World War I, and especially data from Macaulay(1938)and the volatility af the liabilities of business failures nd Bradstreet(Citibase (1978)). Neither of these "real activity"variables was stro