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A Simple Explanation of Stock Price Behavior in the Long Run: Evidence for Denmark

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  • Jan Overgaard Olesen
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    Abstract

    Using Danish data for the post-World War II-period, we estimate a simple model for the long-run behavior of stock prices. We find a stable and strong cointegrating relation between stock prices and two macroeconomic “fundamentals” variables, firm profits and the nominal bond rate. Both “fundamentals” are highly significant. Growth in profits drives the long-run trend in stock prices while the bond rate explains the observed large deviations from trend growth. The behavior of the bond rate accounts for the evident split of the Danish stock market into a bearish period before the early 1980s and a subsequent bullish period. Likewise, a decline in the bond rate explains a major part of the large capital gains realized in recent years.

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    Paper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 00-09.

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    Handle: RePEc:kud:epruwp:00-09

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    1. Kwiatkowski, D. & Phillips, P.C.B. & Schmidt, P., 1990. "Testing the Null Hypothesis of Stationarity Against the Alternative of Unit Root : How Sure are we that Economic Time Series have a Unit Root?," Papers 8905, Michigan State - Econometrics and Economic Theory.
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    3. John H. Cochrane, 1998. "Where is the Market Going? Uncertain Facts and Novel Theories," NBER Working Papers 6207, National Bureau of Economic Research, Inc.
    4. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
    5. Johansen, S ren, 2000. "A Bartlett Correction Factor For Tests On The Cointegrating Relations," Econometric Theory, Cambridge University Press, vol. 16(05), pages 740-778, October.
    6. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, . "Noise Trader Risk in Financial Markets," J. Bradford De Long's Working Papers _124, University of California at Berkeley, Economics Department.
    7. Gonzalo, J. & Lee, T.H., 1995. "Pitfalls in Testing for Long Run Relationships," Papers 38, Boston University - Department of Economics.
    8. Phillips, Peter C B & Loretan, Mico, 1991. "Estimating Long-run Economic Equilibria," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 407-36, May.
    9. Robert J. Shiller, 1998. "Designing Indexed Units of Account," Cowles Foundation Discussion Papers 1179, Cowles Foundation for Research in Economics, Yale University.
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