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Extracting Inflation from Stock Returns to Test Purchasing Power Parity

  • Chowdhry, Bhagwan

    (U of California, Los Angeles)

  • Roll, Richard
  • Xia, Yihong

    (University of Pennsylvania)

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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File URL: http://www.anderson.ucla.edu/faculty/bhagwan.chowdhry/ppp.pdf
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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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