Inflation and World Equity Selection

Abstract

Although much has been written about inflation and stock returns in the United States and the United Kingdom, little is known about the impact of inflation on a broader menu of countries. Consistent with previous research examining time series of inflation and stock returns in the United States, this study of inflation in 41 developed and emerging equity markets documents a significant negative relation for most countries. Cross-sectional analysis, however, indicates that inflation, as a country attribute, commands a positive premium. This finding suggests that inflation reveals information about risk exposure. Supporting the risk interpretation, the correlation between a country's inflation rate and the OECD rate of inflation is positively related to the country's equity return correlation with world market returns. Further, equity volatility is positively linked to average inflation rates. More than 50 percent of the cross-sectional variation in average inflation rates can be accounted for by country cr...