Expected Inflation and Asset Returns: Some International Evidence

Abstract

This paper investigates the inflation-hedging properties of three asset classes, namely common stocks, bonds and real estate, for thirty-one selected countries which are at different stages of development. Quarterly data for these countries over the period 1973-2017 are deployed for estimation purposes. Empirical results obtained for most countries in the sample do not show any positive or significant relationship between the actual, expected or unexpected inflation and stock returns. In contrast, consistent with the extant literature, results show an anomalous or puzzling negative relationship between inflation and stock returns. Unlike the stock returns, the bond returns are found to respond positively and significantly to expected inflation, but not much to unexpected inflation. This finding suggests that unlike common stocks, the bonds can be considered a better hedge against expected inflation. These findings suggest that in so far as unexpected inflation is concerned, neither common stocks nor bonds qualify as inflation hedges. However, unlike the stock returns and bond returns, real-estate (housing) returns are found to respond positively and significantly to actual, expected and unexpected inflation. This outcome suggests that real estate qualifies as an inflation hedge irrespective of actual, expected or unexpected inflation. The findings could be useful to design an asset management strategy in the context of high and volatile, and hence unexpected, inflation in developing countries.

Keywords: Asset returns, Expected inflation, International evidence

JEL Classification: G1, E4, E440