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Extracting Inflation from Stock Returns to Test Purchasing Power Parity

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  • Chowdhry, Bhagwan

    (U of California, Los Angeles)

  • Roll, Richard
  • Xia, Yihong

    (University of Pennsylvania)

Abstract

We provide a novel method for extracting estimates of realized pure price inflation from stock returns. The key is recognizing that pure price inflation should affect nominal returns of all traded assets by exactly the same amount. The popular Fama-French three-factor model is employed to purge stock returns of real economic factors. We uncover evidence that purchasing power parity holds quite well using the extracted inflation measures.

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Bibliographic Info

Paper provided by University of Pennsylvania, Wharton School, Weiss Center in its series Working Papers with number 03-1.

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Date of creation: Jun 2003
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Handle: RePEc:ecl:upafin:03-1

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Cited by:
  1. 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.
  2. Georgios Chortareas & George Kapetanios, 2004. "Getting PPP Right: Identifying Mean Reverting Real Exchange Rates in Panels," Money Macro and Finance (MMF) Research Group Conference 2004 32, Money Macro and Finance Research Group.
  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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