Working Paper No. 692
By Will Dison and Konstantinos Theodoridis
We investigate the role of macroeconomic shocks in driving equity price dynamics, focusing in particular on the United Kingdom as a small open economy. Using a vector error correction model estimated on 34 macroeconomic and financial time series, we show that shocks to demand, supply, monetary policy and total factor productivity account for a significant proportion of the variation in both UK and US equity prices. In contrast to some of the earlier literature, we find that shocks to total factor productivity play a particularly important role in explaining equity price movements, particularly at longer horizons. Reflecting the international nature of the FTSE All-Share, we find that most of the variation in UK equity prices is accounted for by foreign shocks, even for relatively UK-focused sectors.
Working Paper No: 692