Abstract
Empirical tests of the Fisher hypothesis give conflicting results, regardless of whether income growth is accommodated in the estimates. This paper shows theoretically and empirically that standard methods of testing the Fisher hypothesis give biased results and that the bias depends on the specification of the Fisher equation, the process governing inflation, measurement of inflation expectations, and the time aggregation of the data. Alternative tests show that share markets take several years to adjust to innovations in inflation and therefore that the Fisher hypothesis cannot be maintained.
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Helpful comments and suggestions from Hans Christian Kongsted, Darrel Turkington and seminar participants at the University of Western Australia, and University of Konstanz and, particularly, two referees, are gratefully acknowledged.
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Madsen, J.B. Pitfalls in estimates of the relationship between stock returns and inflation. Empirical Economics 33, 1–21 (2007). https://doi.org/10.1007/s00181-006-0080-7
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DOI: https://doi.org/10.1007/s00181-006-0080-7