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Inflation risk and stock returns: Evidence from US aggregate and sectoral markets

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  • Chiang, Thomas C.
  • Chen, Pei-Ying

Abstract

This study examines the relation between inflation risk and stock returns and finds a negative relation in US aggregate data. A comparable result is found in other G7 economies. Introducing the inflation-induced equity market volatility as an incremental variable consistently produces a negative effect on stock returns. The same finding holds true for monetary policy uncertainty, which also produces a negative relation. Ignoring these two elements will produce a biased estimator of inflation’s effect on stock returns. Testing of sectoral stocks in the US market indicates that most sectors find a significant number of sectors exhibit negative inflation coefficients, confirming the Fama proxy hypothesis. The exception is the energy sector that presents a positive sign, indicating a hedging capacity against inflation. Including the interacting term between a change in monetary policy uncertainty and lagged equity market volatility, the evidence suggests an enhanced negative effect on stock returns.

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  • Chiang, Thomas C. & Chen, Pei-Ying, 2023. "Inflation risk and stock returns: Evidence from US aggregate and sectoral markets," The North American Journal of Economics and Finance, Elsevier, vol. 68(C).
    • Handle: RePEc:eee:ecofin:v:68:y:2023:i:c:s1062940823001092
    DOI: 10.1016/j.najef.2023.101986
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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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