Is AIG a fundamentally sound company that was adversely affected by the current liquidity crisis in a way that is not representative of its long run prospects? The plot above provides one answer to this question.If stock prices are a good measure of the long-run value of the firm, then changes in the stock price should reflect changes in firm value. The plot above decomposes the weekly returns to three of the important players in the government's interventions of the last 6 months up to just prior to the announcement of the AIG bailout. I have filtered the data using Christiano and Fitzgerald's band pass filter into changes to firm value that come from high frequency movements (less than 1.5 years), business cycle frequency movements (1.5 to 8 years), long run frequency movements (8 to 20 years) and very long run frequency movements (greater than 20 years).
I recognize that filtering data poses a host of non-trivial statistical and behavioral questions, but let's ignore those for a minute. If the bottom graph represents that variation in AIG's value that comes from short run, temporary effects like the current credit crisis, then it might not be a good measure of AIG's value as a going concern and we can ignore it when thinking about AIG's long run prospects. The top three plots however, indicate that a significant amount of AIG's decrease in value is due to fluctuations at business cycle, long and very long term frequencies, suggesting that the collapse was not brought on by temporary market conditions alone.
The graph suggests that AIG's downfall was not simply the temporary decrease in liquidity that defines the current crisis. This decline has been a long time in the making.
