Inflation and Stock Returns II

  •  Samih Azar    


The purpose of this paper is to re-examine the relation between US stock returns, as exemplified by the S&P 500 returns, and the US inflation rate. Recent research finds out no significant relation, whether positive or negative. This paper allows for an endogenous calendar break, in the first instance, and a Markov switching regression with two regimes, in the second instance. The empirical evidence points to the conclusion that the relation between US stock returns and inflation undergoes a shift. In one regime, and in one subsample, the relation is negative and statistically significant, and in the other regime, and in the other subsample, the relation is statistically insignificant. The paper argues that there is no theoretical reason for such a finding. Further scrutiny shows that the results are driven by both conditional heteroscedasticity of the regression residuals, and a non-stationary statistical behavior of the inflation variable. The conclusion therefore remains strong that inflation is irrelevant for stock returns.

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