Stock returns and inflation : an econometric study based on pooled time-series and cross-sectional data

The purpose of this dissertation is to test the effect of inflation on common stock returns. Alternative hypotheses about the relationship between inflation and stock returns have been developed and tested, however, the empirical results are far from conclusive. Some studies even found anomalous results which contradict the predictions of the theories.

A review of the literature about the stock return-inflation relationship discovers the major shortcomings with the previous empirical tests. These problems must be overcome before any meaningful conclusions can be drawn. This dissertation is oriented in this direction.

By employing better models and better estimation procedures, the empirical results support the extended Fisher hypothesis which suggests no relationship between expected inflation and real stock return and are consistent with the nominal contracting hypothesis which predicts a negative impact on stock returns due to unexpected inflation. The empirical results in this dissertation also indicate that the magnitude of the wealth-transfer effect on stock returns due to unexpected inflation depends not only on the size but also the maturity of the nominal contracts.