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Equity Returns and Inflation: The Puzzlingly Long Lags

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Author Info

  • James R. Lothian

    (Fordham University)

  • Cornelia H. McCarthy

    (Fordham University)

Abstract

This paper examines data for stock prices and price levels of 14 developed countries during the post-WWII era and compares their behavior in that sample with behavior over the past two centuries in the UK and the US. Contrary to much of the literature of the past several decades, we find that nominal equity prices do, in fact, keep pace with movements in the overall price level. Our results suggest, however, that this is only the case over long periods. The puzzle therefore is not that equities fail the test as inflation hedges, as had been quite widely believed, but that they take so long to pass.

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Bibliographic Info

Paper provided by EconWPA in its series International Finance with number 0311007.

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Date of creation: 12 Nov 2003
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Handle: RePEc:wpa:wuwpif:0311007

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Web page: http://128.118.178.162

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Keywords: Stock prices; inflation; Fisher effect; neutrality; cointegration.;

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References

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  1. Choudhry, Taufiq, 2001. "Inflation and rates of return on stocks: evidence from high inflation countries," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 11(1), pages 75-96, March.
  2. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
  3. Crowder, William J & Hoffman, Dennis L, 1996. "The Long-Run Relationship between Nominal Interest Rates and Inflation: The Fisher Equation Revisited," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(1), pages 102-18, February.
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  9. Geske, Robert & Roll, Richard, 1983. " The Fiscal and Monetary Linkage between Stock Returns and Inflation," Journal of Finance, American Finance Association, vol. 38(1), pages 1-33, March.
  10. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
  11. Martin Feldstein, 1978. "Inflation and the Stock Market," NBER Working Papers 0276, National Bureau of Economic Research, Inc.
  12. Robert J. Shiller & Pierre Perron, 1985. "Testing the Random Walk Hypothesis: Power versus Frequency of Observation," NBER Technical Working Papers 0045, National Bureau of Economic Research, Inc.
  13. James Lothian & Yusif Simaan, 1998. "International Financial Relations Under the Current Float: Evidence from Panel Data," Open Economies Review, Springer, vol. 9(4), pages 293-313, October.
  14. Lothian, James R. & Taylor, Mark P., 1997. "Real exchange rate behavior," Journal of International Money and Finance, Elsevier, vol. 16(6), pages 945-954, December.
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  17. O'Connell, Paul G. J., 1998. "The overvaluation of purchasing power parity," Journal of International Economics, Elsevier, vol. 44(1), pages 1-19, February.
  18. Boudoukh, Jacob & Richardson, Matthew, 1993. "Stock Returns and Inflation: A Long-Horizon Perspective," American Economic Review, American Economic Association, vol. 83(5), pages 1346-55, December.
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Cited by:
  1. Shaun K. Roache & Alexander P. Attie, 2009. "Inflation Hedging for Long-Term Investors," IMF Working Papers 09/90, International Monetary Fund.

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