Stock Returns, Inflation and Macroeconomy: The Long- and Short-Run Dynamics

26 Pages Posted: 21 Dec 2001

See all articles by Marc Chopin

Marc Chopin

Louisiana Tech University - Department of Economics and Finance

Maosen Zhong

University of Queensland - Business School

Multiple version iconThere are 2 versions of this paper

Date Written: May 10, 2000

Abstract

We re-examine the inverse relationship between stock returns and inflation in the post- World War II period. Fama (1981) theorizes that the inverse inflation-stock return correlation is a proxy for the negative relationship between inflation and real activity. Geske and Roll (1983) argue that the inflation-stock return correlation reflects changes in government expenditures, real economic conditions and monetization of budget deficits. We test these hypotheses simultaneously using a multivariate vector-Error-Correction Model (VECM) proposed by Johansen and Juselius (1992, 1994). We find that both real activity and monetary fluctuations generate the contemporaneous correlation between stock returns and inflation. However, the Federal Reserve bank seems not to monetize Federal deficits, nor do government deficits appear to drive changes in real economic activity during the period examined. Thus, our results appear more compatible with Fama's explanation than that of Geske and Roll. More intriguingly, the sources of both real activity and monetary fluctuations are the long-run disequilibria of macroeconomy.

Keywords: Stock Return, Inflation, Vector Error Correction Model, Long-run equilibrium

JEL Classification: G10, G18

Suggested Citation

Chopin, Marc and Zhong, Maosen, Stock Returns, Inflation and Macroeconomy: The Long- and Short-Run Dynamics (May 10, 2000). Available at SSRN: https://ssrn.com/abstract=294500 or http://dx.doi.org/10.2139/ssrn.294500

Marc Chopin

Louisiana Tech University - Department of Economics and Finance ( email )

Ruston, LA 71272
United States
318-257-4464 (Phone)
318-257-4253 (Fax)

Maosen Zhong (Contact Author)

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

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