Does inflation exaggerate the equity premium?

Kyriacou, Kyriacos; Madsen, Jakob B.; Mase, Bryan

doi:10.1108/01443580610706573

Cited by 16 publications

(16 citation statements)

References 33 publications

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“…A one percentage point rise (fall) in inflation increases (decreases) the ERP by 0.65 percentage points. The estimated inflation impact using the more appropriate expected equity return is 1½ times higher than the 43% reported in Kyriacou et al (2006). The latter use realized annual actual equity returns for a panel of 10 OECD countries over the period 1914 to 2002.…”

Section: Resultsmentioning

confidence: 96%

“…Recent studies suggest a shrinking equity premium and levels which are lower than a previous thought level of about 6% (Siegel, 1999;Jagannathan et al, 2000;Claus and Thomas, 2001;Azar, 2007;Campbell, 2007). Inspired by Kyriacou et al (2006) we examine the empirical link between the equity premium and inflation. Instead of using the actual equity return, we use the expected stock return based on the dividend yield and the earnings growth rate, as introduced by Fama and French (2002).…”

Section: Introductionmentioning

confidence: 96%

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The equity premium and inflation

Beirne

Bondt

2008

Applied Financial Economics Letters

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This empirical study examines the relation between the equity premium - the difference between the expected stock and risk-free return - and inflation in the major economies in the post-Bretton Woods era. We estimate a country-average level of the equity premium between 0.8% and 2%, confirming a shrinking premium. Regressions and impulse responses show that the equity premium significantly positively adjusts to inflation. Inflation is thus essential in explaining the level of the equity premium and provides a partial resolution to the equity premium puzzle.

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Section: Resultsmentioning

confidence: 96%

Section: Introductionmentioning

confidence: 96%

The equity premium and inflation

Beirne

Bondt

2008

Applied Financial Economics Letters

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“… The hypothesis that inflation increases the general risk aversion and hence equity risk premia, as suggested by Brandt and Wang (2003). Kyriacou, Madsen, and Mase (2006) and Madsen and Dzhumashev (2009) also suggested that inflation drives up the equity risk premium.  The tax hypothesis which focuses on taxes and the adverse impacts of inflation, including Nichols (1968), Motley (1969), Feldstein (1980), and Summers (1981).…”

Section: Literature Reviewmentioning

confidence: 97%

“…There are several studies suggesting that the equity risk premium increase with inflation, among others Brandt and Wang (2003), Buraschi and Jiltsov (2005), Kyriacou et al (2006), Tristani (2007), Beirne and de Bondt (2008), and Madsen and Dzhumashev (2009). Cohen et al (2005) found that the equity risk premium varies with inflation, indicating that inflation illusion might explain the higher risk premium as inflation rise.…”

Section: Risk Premiummentioning

confidence: 98%

Deflation and Stock Prices

Clemens¹

2019

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While the literature on inflation and stock prices is plentiful, there is little literature on deflation and stock prices. This paper explores the empirical data and makes a theoretical analysis of the likely impact on stock prices when expectations change from inflation to deflation. Deflation has a bad name among some economists and most investors. However, from a stock market perspective, deflations' bad name may not be well-deserved. Several observations support this: 1) The 1930s was a statistical outlier and not representative for a deflationary period and deflation does not seem to create recessions, causality goes the other way; 2) real stock returns are positive and around average in the periods leading up to and following the onset of deflation; 3) when moving from low inflation to mild deflation, P/E ratios are virtually unchanged; and 4) peak P/E ratios seem to be reached at inflation rates close to zero. The author proposes three possible explanations for the seemingly disconnect between the empirical data and the "default" ex ante belief of most economists and investors: availability heurist, deflation illusion, and tax related issues in connection with the tax hypothesis.

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“…This relation has not received all the attention that it deserves. Exceptions are Yaansah and Peasnell (1994), Kyriacou et al (2006), Beirne and de Bondt (2008), and Madsen and Dzhumasher (2009). The literature has mostly covered the relations between nominal and real stock returns with inflation.…”

Section: Introductionmentioning

confidence: 99%

The Equity Premium and Inflation: Evidence from the US

Azar

2015

AFA

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There is recent and strong evidence that nominal stock returns are independent of inflation. In what amounts to the same thing, when real stock returns are regressed on inflation the resulting estimated coefficient on inflation is negative and unitary. These two propositions are mathematically equivalent. The purpose of this paper is to show that the market stock return is also independent of expected inflation, as measured by the T-bill rate. Firstly, regressions of the equity premium on inflation produce invariably slope coefficients that are statistically insignificantly different from -1. The inflation variable on the right hand side of the regression picks up the sign and the magnitude of the T-bill rate in the equity premium on the left hand side of the regression. This is as expected because the T-bill rate is an unbiased predictor of the future inflation rate, or, in other terms, the T-bill rate is a proxy for expected inflation. Hence regressions of real stock returns on inflation are in substance the same as regressions of the equity premium on inflation, and in both cases nominal stock returns are independent of inflation, and of its expected proxy, the T-bill rate. Secondly, additional evidence is provided from regressions of stock market returns on the inflation rate and the T-bill rate taken together. The hypothesis that the sum of the two coefficients on these two variables is statistically insignificantly different from zero is strongly supported. Moreover, the joint null hypothesis that the first coefficient is equal to -1 and that the second coefficient is equal to +1 is also strongly supported. As a conclusion stock prices already reflect macroeconomic shocks and there is neither money illusion nor over and under adjustment on the part of investors.

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Does inflation exaggerate the equity premium?

Cited by 16 publications

References 33 publications

The equity premium and inflation

The equity premium and inflation

Deflation and Stock Prices

The Equity Premium and Inflation: Evidence from the US

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