Stock returns during the German hyperinflation

Abstract

We examine the relationship between stock returns and inflation during the German hyperinflation period. As Cagan (1956) argues, hyperinflation is close to a pure monetary phenomenon, the monetary sector is almost isolated from the real sector of the economy. We can thus study the impact of inflation on common stock returns directly, unaffected by the potential interactions of other economic variables such as expected real output. The negative relationship between inflation and stock returns widely reported in the literature may be spurious because they have not made such a distinction. By using forward exchange rate premium as a proxy for expected inflation, we find that stock returns, inflation, expected inflation, and unexpected inflation are cointegrated during the German hyperinflation period. The results also indicate that the fundamental relationship between stock returns and both realized and expected inflation is highly positive. JEL classification: E310; G120