Fundamental UK stock prices as determined by the macroeconomy

Abstract

This study uses a restricted vector-autoregressive model to derive a fundamental share price index that relates aggregate real share prices to real macroeconomic activity in the UK. The sample period covered is January 1974–December 2002. The analysis shows that actual (real) stock prices in the UK take long swings away from fundamental stock prices. It is noted that actual (real) stock prices fell below fundamental (real) stock prices in December 2002 for the first time since 1990.