Abstract
Correlations of stock returns change randomly through time. The variations in correlations are themselves correlated across pairs of stocks. In an equilibrium model, investor uncertainty regarding the growth rate of the economy is the factor driving systematic variations in R square, pairwise correlations, market volatility and volatilities of interest rates. uncertainty regarding the idiosyncratic component of firm growth rate explains non-systematic variations in R square. Consistent with the model, data show that the volatility of interest rates represents investor uncertainty and predicts the average in the stock market.
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