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Stock returns and economic activity: the UK case

  • David Lovatt
  • Ashok Parikh

This paper investigates the relationships between real stock returns and a number of financial and economic variables for the UK economy for the period 1980 to 1994. We begin by discussing a theoretical model proposed by Balvers et al. and then re-estimate for the UK what may be regarded as an application of that model by Fama applied to the US market. This reproduces Fama's main results. For the UK we than suggest a slightly, different application of the Balvers model, the most important feature of which is the use of expectational macro-economic variables instead of Fama's use of leading values of industrial production. We then go on to investigate the unit root properties of the data and show that much of the data is indeed characterized by the presence of unit root non stationarity In the light of this, we propose an application of the Phillips-Loretan error-correction model and show that this provides a plausible relationship between real stock returns and most of the financial and economic variables.

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Article provided by Taylor & Francis Journals in its journal The European Journal of Finance.

Volume (Year): 6 (2000)
Issue (Month): 3 ()
Pages: 280-297

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Handle: RePEc:taf:eurjfi:v:6:y:2000:i:3:p:280-297
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References listed on IDEAS
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  1. Perron, P, 1988. "The Great Crash, The Oil Price Shock And The Unit Root Hypothesis," Papers 338, Princeton, Department of Economics - Econometric Research Program.
  2. 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.
  3. Black, Angela & Fraser, Patricia, 1995. "U.K. Stock Returns: Predictability and Business Conditions," The Manchester School of Economic & Social Studies, University of Manchester, vol. 63(0), pages 85-102, Suppl..
  4. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
  5. David Morelli, 1999. "Tests of structural change using factor analysis in equity returns," Applied Economics Letters, Taylor & Francis Journals, vol. 6(4), pages 203-207.
  6. James M. Poterba & Lawrence H. Summers, 1987. "Mean Reversion in Stock Prices: Evidence and Implications," NBER Working Papers 2343, National Bureau of Economic Research, Inc.
  7. Balvers, Ronald J & Cosimano, Thomas F & McDonald, Bill, 1990. " Predicting Stock Returns in an Efficient Market," Journal of Finance, American Finance Association, vol. 45(4), pages 1109-28, September.
  8. Ashok Parikh & David Lovatt, 1998. "Modelling real capital gains in the UK stock market," Applied Economics Letters, Taylor & Francis Journals, vol. 5(6), pages 337-342.
  9. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
  10. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
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