The Relationship Between Stock Market Returns and Rates of Inflation

Abstract

FOLLOWING SOME RECENT RESEARCH published in the Journal of Finance (Bodie [1], Jaffe & Mandelker [4] and Nelson [7]), this paper examines the relationship between inflation and the rates of return on common stocks using British data. As with the articles by Jaffe & Mandelker and Nelson the basic hypothesis being tested is 'that expected rates of return on common stocks consist of a return plus the expected rate of inflation and that the real rate of return is independent of the expected rate of inflation'; this hypothesis has been referred to as the 'Fisher effect', (see Jaffe & Mandelker [4]) following the work of Irving Fisher [3]. The results for the recent past show that, contrary to American studies based on similar periods (Bodie [1], Fama & Schwert [2], Jaffe and Mandelker [4], Lintner [5], Nelson [7] and Oudet [8]), stock market returns in Britain do provide some support for the 'Fisher effect'. Additionally there was no statistically significant evidence that publicly available information on rates of inflation could be used to earn superior stock market returns.