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Do UK stock prices deviate from fundamentals?

Author

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  • Allen, D.E
  • Yang, W

Abstract

This article examines the deviation of the UK total market index from market fundamentals implied by the simple dividend discount model and identifies other components that also affect price movements. The components are classified as permanent, temporary, excess stock return and non-fundamental innovations to stock prices by employing a multivariate moving-average model as applied in [J. Financial Quant. Anal. 33 (1998) 1] and imposing relevant restrictions on the model in light of Sims–Bernanke forecast error variance decomposition. We find that time-varying discounted rates play an active role in explaining price deviations. Under the assumption of constant expected excess returns, a substantial proportion of price movements observed is due to un-explained market non-fundamental innovations (Model I). However, the un-explained portion dropped dramatically once the excess stock returns were allowed to change over time and incorporated in the model (Model II). Amongst other implications, this finding suggests that apart from the dividends, the deviation in stock prices can also be attributed to other market fundamental elements.

Suggested Citation

  • Allen, D.E & Yang, W, 2004. "Do UK stock prices deviate from fundamentals?," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 64(3), pages 373-383.
  • Handle: RePEc:eee:matcom:v:64:y:2004:i:3:p:373-383
    DOI: 10.1016/S0378-4754(03)00103-4
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    References listed on IDEAS

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    Cited by:

    1. Rambaccussing, Dooruj, 2010. "A real-time trading rule," MPRA Paper 27148, University Library of Munich, Germany.
    2. repec:eee:quaeco:v:66:y:2017:i:c:p:115-126 is not listed on IDEAS
    3. Ma, Jun & Wohar, Mark E., 2014. "Determining what drives stock returns: Proper inference is crucial: Evidence from the UK," International Review of Economics & Finance, Elsevier, vol. 33(C), pages 371-390.
    4. repec:taf:oabmxx:v:3:y:2016:i:1:p:1154283 is not listed on IDEAS
    5. Binswanger, Mathias, 2004. "How do stock prices respond to fundamental shocks?," Finance Research Letters, Elsevier, vol. 1(2), pages 90-99, June.
    6. Narayan, Paresh Kumar, 2006. "The behaviour of US stock prices: Evidence from a threshold autoregressive model," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 71(2), pages 103-108.
    7. Jean Louis, Rosmy & Eldomiaty, Tarek, 2010. "How do stock prices respond to fundamental shocks in the case of the United States? Evidence from NASDAQ and DJIA," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(3), pages 310-322, August.

    More about this item

    Keywords

    Sims–Bernanke variance decomposition; Trivariate moving-average;

    JEL classification:

    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting

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