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Stock Returns-Inflation Relation in India

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  • K.R. Shanmugam

    (MSE)

  • Biswa Swarup Misra

Abstract

This study contributes to the stock returns-inflation relation literature in developing countries by revisiting the issue with reference to the emerging economy, India. More specifically, it tests whether the Indian stock market provides an effective hedge against inflation usingmonthly data on real stock return, inflation and real activity from April 1980 to March 2004 and a two-step estimation procedure. Results of the study indicate that (i) the Indian stock market reflects future real activity; (ii) the negative stock returns-inflation relation emerges fromthe unexpected component of the inflation and (iii) this negative relation vanishes when we control for the inflation-real activity relation, thereby providing a strong support for Famas proxy effect hypothesis. The split sample analyses indicate that the Fama hypothesis is valid only in pre reformperiod. In the post reform period, real stock returns have been independent of inflation, i.e., the Fisher Hypothesis is valid.

Suggested Citation

  • K.R. Shanmugam & Biswa Swarup Misra, 2008. "Stock Returns-Inflation Relation in India," Finance Working Papers 22514, East Asian Bureau of Economic Research.
  • Handle: RePEc:eab:financ:22514
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    References listed on IDEAS

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    1. Floros, C., 2004. "Stock Returns and Inflation in Greece," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 4(2).
    2. S. I. Spyrou, 2004. "Are stocks a good hedge against inflation? evidence from emerging markets," Applied Economics, Taylor & Francis Journals, vol. 36(1), pages 41-48.
    3. Ram, Rati & Spencer, David E, 1983. "Stock Returns, Real Activity, Inflation, and Money: Comment," American Economic Review, American Economic Association, vol. 73(3), pages 463-470, June.
    4. Rapach, David E., 2002. "The long-run relationship between inflation and real stock prices," Journal of Macroeconomics, Elsevier, vol. 24(3), pages 331-351, September.
    5. Firth, Michael, 1979. "The Relationship between Stock Market Returns and Rates of Inflation," Journal of Finance, American Finance Association, vol. 34(3), pages 743-749, June.
    6. Arjun Chatrath & Sanjay Ramchander & Frank Song, 1997. "Stock prices, inflation and output: evidence from India," Applied Financial Economics, Taylor & Francis Journals, vol. 7(4), pages 439-445.
    7. Keshab Shrestha & Sheng-Syan Chen & Cheng-few Lee, 2002. "Are Expected Inflation Rates and Expected Real Rates Negatively Correlated? A Long-Run Test of the Mundell-Tobin Hypothesis," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 25(3), pages 305-320.
    8. Fama, Eugene F, 1982. "Inflation, Output, and Money," The Journal of Business, University of Chicago Press, vol. 55(2), pages 201-231, April.
    9. Bodie, Zvi, 1976. "Common Stocks as a Hedge against Inflation," Journal of Finance, American Finance Association, vol. 31(2), pages 459-470, May.
    10. 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.
    11. Lintner, John, 1975. "Inflation and Security Returns," Journal of Finance, American Finance Association, vol. 30(2), pages 259-280, May.
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    Cited by:

    1. Rangan GUPTA & Roula INGLESI-LOTZ, 2012. "Macro Shocks and Real US Stock Prices with Special Focus on the “Great Recession”," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 12(2).
    2. repec:spr:jqecon:v:16:y:2018:i:1:d:10.1007_s40953-017-0075-6 is not listed on IDEAS
    3. Muhammad Shahbaz & Faridul Islam & Ijaz Ur Rehman, 2016. "Stocks as Hedge against Inflation in Pakistan: Evidence from ARDL Approach," Global Business Review, International Management Institute, vol. 17(6), pages 1280-1295, December.

    More about this item

    Keywords

    Stock Return; inflation;

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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