Abstract
An important question that has been asked extensively in the financial economics literature is whether nominal returns contain market assessments of expected and unexpected inflation rates, and whether common stocks are an effective hedge against inflation. However, theoretical attempts to examine the relation between stock returns and inflation diverge. While some studies found a significant negative relationship between unexpected inflation and stock returns (Bodie 1976, Jaffe and Mandelker 1976, Nelson 1976, Fama and Schwert 1977, Fama 1981, Schwert 1981), others found no significant relationship (Pearce and Roley 1985, Hardouvelis 1987, McQueen and Roley 1993). In theses studies, unexpected inflation was created from time series estimation of expected inflation, from the difference between nominal interest rats and inflation, or from experts’ predictions.
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