Testing the nexus between stock market returns and inflation in Nigeria: Does the effect of COVID-19 pandemic matter?

Abstract

Given the palpable fear generated by the threat of COVID‐19 pandemic and the bearish sentiments of stock investors, this study represents one of the first efforts towards testing the effect of COVID‐19 on the stock market returns‐inflation relationship. Specifically, the study investigates the stock market returns–inflation nexus by controlling for the effect of COVID‐19 pandemic in Nigeria from February 27, 2020 to April 30, 2020. Using the estimation procedures based on the generalized autoregressive conditional heteroskedasticity type models (GARCH (1,1), the GJR‐GARCH), and the accounting innovation tests, our results show that COVID‐19 increases volatility and distorts the positive relationship between inflation and stock market returns, which tends to negate the Fisher's hypothesis. In addition, the results reveal that the negative effects of COVID‐19 on the market returns and its disruption to the stock market returns—inflation relationship may not die away rapidly considering that the duration of the pandemic is unknown. Further, these findings are validated by the innovation accounting tests. Therefore, the study presents to policymakers the consequences of COVID‐19 and the urgent need to strengthen the market through collaborative efforts.