IS THE GILT-EQUITY YIELD RATIO USEFUL FOR PREDICTING UK STOCK RETURNS

The ratio of a long government bond yield to the equity market divided yield, the Gilt-Equity Yield Ratio (GEYR), is commonly used by analysts in the UK as a mean, of determining the cheapness of equity investment relative to investment in gilts. Analysts use the ratio to predict future movements in equity prices using buy/sell thresholds, implicitly assuming that there is a long-run arbitrage relation between the equity market and the government bond market. A formal econometric analysis confirms that the GEYR is indeed a useful predictor of equity returns in the UK.