Empirical Analysis of Effects of Expected Inflation on Stock Returns

Abstract

We adopted asymmetric test specification model to investigate implications of expected inflation on stock returns. While to calculate expected inflation, two methods, Fama money demand model (1981) and ARMA model were employed. Monthly data is obtained covering data span of August 1998 to June 2018 from concerned sources. The results show a strong relationship between real stock returns (adjusted from inflation) and expected inflation while utmost an insignificant relationship between nominal stock returns and predicted inflation. An inverse relationship amidst stock returns and inflation is observed during only low inflation time period in contrast to high inflation time period (positive relationship). The impact of expected inflation on stock returns by dividing the sample period into sub periods provides insignificant relationship between stock returns and expected inflation which is obvious as stock returns behaves noisy in short time period.