Using aggregate and industry-wise monthly UK data over a period of 44 years we
examine the long run relationship between stock return index (St) and retail price index
(Pt) in a VAR framework. Univariate tests confirm Pt as I(2); nevertheless pairs of St
and Pt are co-integrated and share common I(1) trend. There is no evidence of shared
I(2) trend. We find evidence of shifts in the co- integrating ranks and parameters, and
accounting for these shifts improved estimates’ precision. The long run price elasticity
of return index is consistently above unity, a finding that stands in sharp contrast to the
existing ones. Overall our results suggest that tax-paying stock investors are fully
insulated against inflation in the long run
