Review of Quantitative Finance and Accounting, 22: 123–140, 2004
2004 Kluwer Academic Publishers. Manufactured in The Netherlands.
Stock Prices and Inﬂation: New Evidence
from the Paciﬁc-Basin Countries
OSAMAH M. AL-KHAZALI
School of Business and Management, American University of Sharjah, P.O. Box 26666, Sharjah, U.A.E.
Tel.: (971) 6-5152320; Fax: (971) 6-5585065
CHONG SOO PYUN
Department of Finance, University of Memphis, Memphis, TN 38152, USA Tel.: (901) 678-4645,
Fax: (901) 678-2685
Abstract. This paper investigates the statistical relationship between stock prices and inﬂation in nine countries
in the Paciﬁc-Basin. On balance, regression analysis on the nine markets shows negative relationships between
stock returns in real terms and inﬂation in the short run, while co-integration tests on the same markets display a
positive relationship between the same variables over the long run. The time path of the response of stock prices
plotted against corresponding changes in consumer price indices validates this dichotomy in time-related response
patterns of stock prices to inﬂation; namely, a blip of negative responses at the beginning changes to a positive
response over a longer period of time. Stock prices in Asia, like those in the U.S. and Europe, appear to reﬂect a
time-varying memory associated with inﬂation shocks that make stock portfolios a reasonably good hedge against
inﬂation in the long run.
Keywords: inﬂation and stock markets, Fisher effect, Paciﬁc-Basin stock markets
JEL Classiﬁcation: G10, G15, C32
Viewed from the vantage point of the generalized Fisher hypothesis, equity stocks, which
represent claims against the real assets of a business, may serve as a hedge against inﬂation.
Following this line of reasoning, investors would engage in a form of arbitrage, selling
ﬁnancial assets in exchange for real assets when expected inﬂation is pronounced. Central
to this particular form of the Fisher effect, linking stock prices to corresponding changes in
inﬂation, is the proposition that stock prices in nominal terms fully reﬂect expected inﬂation
and that the statistical relationship between the movement of these two variables can be
found positively correlated ex ante.
Literature on tests of the generalized Fisher hypothesis is mixed. Many studies have found
evidence of what has become known as the inverted Fisher hypothesis, namely that changes
in both expected and unexpectedinﬂation are negatively correlated with stock returns.