Stock returns and inflation in Pakistan

Abstract

The nexus between stock returns and inflation is assessed for Pakistan using the methodology of frequency based causality and continuous wavelet transform over a long sample period 1961:M07–2012:M02. The preliminary investigation using the frequency based causality suggests interdependence of stock return and inflation. Our deeper investigation using the tools of wavelet coherency and wavelet phase angle in the continuous wavelet transform framework, however, explore dependency between stock returns and inflation over certain time periods; especially for lower time scales. For higher time scales, the study finds stock returns and inflation to be in the phase (positively related) when consumers' price inflation is considered and independent when producers' price inflation is utilized. Overall results based on both the inflation measures indicate that, inflation does not erode the value of stocks in Pakistan and stocks could be used as hedge against inflation at least in the long-run.