U.S. stock prices and macroeconomic fundamentals

Using 54 years of US quarterly data and a VAR model underpinned by a theory of therelationship between stock prices and output, this paper considers the deviations ofUS stock prices from their fundamental value. To do this we derive the fundamentalprice-output ratio and the fundamental stock price under different assumptionsregarding the time-variability of returns, and proceed to compare these to actual data.Despite differences between model results, all imply cyclical deviations of actualvalues from values warranted by the expected growth in output - these deviationsbeing relatively large since 1996.