Inflation News and the Stock Market: Macroefficiency or Overreaction

Abstract

Previous studies find only a weak relationship between inflation news and stock market returns. We show that significant daily market reactions to different types of inflation shocks occur in dynamic economic states. Also, although previous work has not examined longer-run market reactions, our results demonstrate large, significant, and slow market responses to both positive and negative inflation shocks in the post-event month. Stock return reversals are common in months subsequent to large market response to inflation shocks. In both daily and monthly analyses we find instances in which stock returns are not inversely related to inflation shocks. These and other findings lead us to conclude that inflation shocks are important news events that can produce a variety of stock market reactions depending on economic state and type of inflation shock. Our evidence also suggests that inflation shocks can generate stock market overreactions in some cases.