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Inflation illusion or no illusion: what did pre- and post-war data say?

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Author Info

  • Chao Wei
  • Fred Joutz

Abstract

Campbell and Vuolteenaho (CV, 2004) empirically decompose the S&P 500's dividend yield from 1927 to 2002 to derive a measure of residual mispricing attributed to inflation illusion. They argue that the strong positive correlation between the mispricing component and inflation is strong evidence for the inflation illusion hypothesis. We find evidence for structural instability in their prediction equation for the excess return. We apply the same decomposition approach to the data before and after 1952, and find that the correlation between inflation and the mispricing component is close to zero in the post-war period, when inflation and the dividend yield are strongly positively correlated. The post-war data do not support the inflation illusion hypothesis as the explanation for the positive correlation between inflation and dividend yields.

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File URL: http://www.tandfonline.com/doi/abs/10.1080/09603107.2011.587771
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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 21 (2011)
Issue (Month): 21 ()
Pages: 1599-1603

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Handle: RePEc:taf:apfiec:v:21:y:2011:i:21:p:1599-1603

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Related research

Keywords: inflation illusion; mispricing; structural instability; decomposition approach;

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Cited by:
  1. Geert Bekaert & Eric Engstrom, 2009. "Inflation and the Stock Market:Understanding the "Fed Model"," NBER Working Papers 15024, National Bureau of Economic Research, Inc.
  2. Francesco Bianchi, 2010. "Rare Events, Financial Crises, and the Cross-Section of Asset Returns," Working Papers 10-40, Duke University, Department of Economics.

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