Stock Returns and Inflation Innovations with State-Dependent Inflation Non-Neutrality

84 Pages Posted: 15 Jun 2019 Last revised: 2 Mar 2021

See all articles by Robert A. Connolly

Robert A. Connolly

Miami Herbert Business School - Department of Finance

Chris T. Stivers

University of Louisville

Licheng Sun

Old Dominion University

Date Written: March 2, 2021

Abstract

We show that the concurrent relation between quarterly stock returns and inflation innovations is appreciable and robustly significant only over weaker economic times, strikingly positive over 1997:Q4-2017:Q4 but negative over 1981:Q3-1997:Q3. Otherwise, the stock-inflation relation is relatively much smaller and near zero to marginally negative over both our pre-1997 and post-1997 periods. We suggest two complementary channels for understanding our main findings. First, we find consistent state-dependent patterns in how inflation innovations are related to expected economic growth and/or the equity risk premium, suggestive of a `state-dependent inflation non-neutrality’ channel. Second, when controlling for more fundamental stock-valuation determinants, the partial stock-inflation relation is diminished modestly but remains important over weaker economic times. Along with other analysis, this suggests a `signaling intensity of inflation' channel where inflation signals are more relevant for identifying the economic state when uncertainty is elevated.

Keywords: Stock Returns, Inflation Expectations, Uncertain Economic States, Economic Growth, the Equity Premium

JEL Classification: G12

Suggested Citation

Connolly, Robert A. and Stivers, Chris T. and Sun, Licheng, Stock Returns and Inflation Innovations with State-Dependent Inflation Non-Neutrality (March 2, 2021). Available at SSRN: https://ssrn.com/abstract=3393830 or http://dx.doi.org/10.2139/ssrn.3393830

Robert A. Connolly

Miami Herbert Business School - Department of Finance ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States

HOME PAGE: http://https://drbobconnolly.com/

Chris T. Stivers (Contact Author)

University of Louisville ( email )

Finance Dept., College of Business
University of Louisville
Louisville, KY 40292
United States
502-852-4829 (Phone)

Licheng Sun

Old Dominion University ( email )

Strome College of Business
Department of Finance
Norfolk, VA 23529-0222
United States

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