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Stock returns and inflation: a macro analysis

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  • Nicolaas Groenewold
  • Gregory O'Rourke
  • Stephen Thomas

Abstract

A negative relationship between stock returns and (expected) inflation is frequently observed in empirical work and is considered a puzzle since it is expected that stocks are a good hedge against inflation, so that their real rate of return (actual or expected) ought to be unaffected by changes in inflation. Various attempts have been made to resolve this puzzle empirically but have tended to use single equations of a partial equilibrium nature which have been ad hoc to a greater or lesser extent. This paper examines the puzzle in the framework of a small empirical macroeconomic model. The negative sign survives the extension to the full model and the source of the puzzle is found in the macroeconomic interactions: a rise in the expected inflation rate raises equilibrium real output which has a negative impact on stock returns.

Suggested Citation

  • Nicolaas Groenewold & Gregory O'Rourke & Stephen Thomas, 1997. "Stock returns and inflation: a macro analysis," Applied Financial Economics, Taylor & Francis Journals, vol. 7(2), pages 127-136.
  • Handle: RePEc:taf:apfiec:v:7:y:1997:i:2:p:127-136
    DOI: 10.1080/096031097333691
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    Citations

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    Cited by:

    1. N. Groenewold, 2000. "Fundamental Share Prices and Aggregate Real Output," Economics Discussion / Working Papers 00-05, The University of Western Australia, Department of Economics.
    2. Sellin, Peter, 1998. "Monetary Policy and the Stock Market: Theory and Empirical Evidence," Working Paper Series 72, Sveriges Riksbank (Central Bank of Sweden).
    3. N. Groenewold, 2000. "Financial Deregulation and the Relationship Between the Economy and the Share Market in Australia," Economics Discussion / Working Papers 00-10, The University of Western Australia, Department of Economics.
    4. Flavin, T. J. & Wickens, M. R., 2003. "Macroeconomic influences on optimal asset allocation," Review of Financial Economics, Elsevier, vol. 12(2), pages 207-231.
    5. Thomas J. Flavin & Michael R. Wickens, 1998. ": A Risk Management Approach to Optimal Asset Allocation," Economics, Finance and Accounting Department Working Paper Series n851298, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
    6. Rudra P. PRADHAN & Mak B. ARVIN & Bele SAMADHAN & Shilpa TANEJA, 2013. "The Impact of Stock Market Development on Inflation and Economic Growth of 16 Asian Countries: A Panel VAR Approach," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 13(1), pages 203-218.
    7. Aktham Maghyereh, 2006. "The long-run relationship between stock returns and inflation in developing countries: further evidence from a nonparametric cointegration test," Applied Financial Economics Letters, Taylor and Francis Journals, vol. 2(4), pages 265-273, July.
    8. Amir Kia, 2001. "Forward-looking Agents and Macroeconomic Determinants of the Equity Price in a Small Open Economy," Emory Economics 0103, Department of Economics, Emory University (Atlanta).
    9. Nicolaas Groenewold, 2004. "Fundamental share prices and aggregate real output," Applied Financial Economics, Taylor & Francis Journals, vol. 14(9), pages 651-661.
    10. Du, Ding, 2006. "Monetary policy, stock returns and inflation," Journal of Economics and Business, Elsevier, vol. 58(1), pages 36-54.

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