'Irrational exuberance' in the long-run UK stock market

Using the macroeconomic data for 1830-2004 in vector error correction models, we find that the UK stock price was largely in line with the equilibrium level. However, the UK stock price shows large and slow-moving positive or negative deviations from the equilibrium, forming cycles of at least a few decades in length. We also show that the equity premium is as low as 3.1% for the 175 years, which is far smaller than the 6 to 7% that has been suggested by many previous studies. Finally, contrary to general belief, the 1999 UK stock price did not appear to be overvalued in our study. We suggest that the 25 years of sharp increase in the UK stock price prior to 1999 can be understood as a mere mean-reversion towards the long-run equilibrium level.