Does inflation matter for equity returns?
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The paper explores the relationship between equity returns and inflation using long-term historical data for four of the largest economies in the world: the US, Japan, the UK and Germany. Unlike most previous studies, the paper explores both the long-term and the short-term dimension of the correlation between equity returns and growth in consumer prices. In general, mixed support was found for the hypothesis of a stable long-run equilibrium relationship, while the short-term analysis showed evidence of an asymmetric behaviour during different inflationary regimes, which could not simply be explained in terms of different economic growth environments. For a long-term investor such as a pension fund, the key implication of these results is that short-term dynamics cannot be completely ignored in the belief that the stock market will turn out to be a perfect inflation hedge in the long run.
Keywordsequity inflation GDP causality vector autoregression
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