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Extracting Inflation from Stock Returns to Test Purchasing Power Parity

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  • Bhagwan Chowdhry
  • Richard Roll
  • Yihong Xia

Abstract

Relative purchasing power parity (PPP) holds for pure price inflations, which affect prices of all goods and services by the same proportion, while leaving relative prices unchanged. Pure price inflations also affect nominal returns of all traded financial assets by exactly the same amount. Recognizing that relative PPP may not hold for the official inflation data constructed from commodity price indices because of relative price changes and other frictions that cause prices to be "sticky," we provide a novel method for extracting a proxy for realized pure price inflation from stock returns. We find strong support for relative PPP in the short run using the extracted inflation measures.

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 95 (2005)
Issue (Month): 1 (March)
Pages: 255-276

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Handle: RePEc:aea:aecrev:v:95:y:2005:i:1:p:255-276

Note: DOI: 10.1257/0002828053828554
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Cited by:
  1. Chortareas, Georgios & Kapetanios, George, 2009. "Getting PPP right: Identifying mean-reverting real exchange rates in panels," Journal of Banking & Finance, Elsevier, vol. 33(2), pages 390-404, February.
  2. Azoulay, Eddy & Brenner, Menachem & Landskroner, Yoram & Stein, Roy, 2014. "Inflation risk premium implied by options," Journal of Economics and Business, Elsevier, vol. 71(C), pages 90-102.
  3. Shiu-Sheng Chen, 2012. "Does extracting inflation from stock returns solve the purchasing power parity puzzle?," Empirical Economics, Springer, vol. 42(3), pages 1097-1105, June.

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