The equity premium and inflation

Beirne, John; Bondt, Gabe de

doi:10.1080/17446540801935389

Cited by 5 publications

(6 citation statements)

References 7 publications

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“…Sharpe (2002) finds no relation between expected inflation and the equity premium. Kyriacou et al (2006), Beirne and de Bondt (2008), and Madsen and Dzhumasher (2009) find a positive and statistically significant relation between inflation and the equity premium. For these latter authors this positive relation explains why the ex post equity risk premium was so high before the 1980s, and they argue that without the effect of inflation there is no longer a risk premium puzzle as propounded in Mehra and Prescott (1985).…”

Section: The Theorymentioning

confidence: 95%

“…For these latter authors this positive relation explains why the ex post equity risk premium was so high before the 1980s, and they argue that without the effect of inflation there is no longer a risk premium puzzle as propounded in Mehra and Prescott (1985). Kyriacou et al (2006) and Beirne and de Bondt (2008) use this positive relation to make the deduction that the equity premium was so high in most of the 20 th century because of the higher inflationary background during that period. Madsen and Dzhumasher (2009) reason that inflation was mostly unexpected before the 1960s, reducing the yield on bonds, and consequently increasing the ex post risk premium.…”

Section: The Theorymentioning

confidence: 99%

“…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%

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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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Section: The Theorymentioning

confidence: 95%

Section: The Theorymentioning

confidence: 99%

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The Equity Premium and Inflation: Evidence from the US

Azar

2015

AFA

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“…At first glance, this seems to be a difficult test for myopic loss aversion theory to sustain, as empirical works in the literature also suggest that simple correlation measures between inflation and equity premium are positive (Beirne and Bondt, 2008; Kyriacou et al , 2006). However, these studies do not attempt to control for any relevant control variables that might lead causality to be different from correlation, and their data focus solely on developed world.…”

Section: Introductionmentioning

confidence: 99%

A systematic test for myopic loss aversion theory

Costa

2018

RBF

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Purpose Myopic loss aversion, or the combination of loss aversion and frequent portfolio evaluation, has been argued to possibly be one of the factors behind the equity premium puzzle. The purpose of this paper is to offer an alternative systematic test that looks at the relationship between inflation and equity premium to test for this theory. Design/methodology/approach Inflation and equity premium tends to be positively associated, both in standard rational-agents theoretical models and in simple empirical measures of correlation. Nonetheless, under the presence of nominal return evaluation, behavioral models such as myopic loss aversion do predict a negative causal relationship between those variables. This study aims to check this negative causal relationship. The identification strategy combines elements of two approaches: fixed effects regression on short-term returns and long-term least squares regression. As both methods have different strengths and weaknesses, and use different sources of data variation to compute their estimators, it is argued that the combination of these approaches provides a better identification strategy than each individual method. Findings This paper finds evidence for a negative relationship between inflation and equity premium in both methods, which supports myopic loss aversion theory. The magnitude of the coefficients is also relevant ranging from −0.23 to −0.80. However, it is also shown that these effects explain only a small part of equity premium observed variation, and are more prevalent in non-industrialized countries, which limits the scope of the theory. Originality/value The current method for testing myopic loss aversion theory is overly reliant on experimental evidence collected in the lab to estimate behavioral parameters and simulations. The authors complement these by providing an empirical study.

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“…It is also claimed that the decrease of equity premium during the Great Moderation is due to the decline of inflation; See Siegel (1999), Jagannathan et al (2000), Claus (2001), andCampbell (2008) for the evidence of decreasing premia and see Beirne and de Bondt (2008) and Kyriacou et al (2006) for empirical estimation of inflation's role in mitigating premia. 4 Labadie (1989) explores two ways that inflation affects equity premium in a theoretical model.…”

Section: Introductionmentioning

confidence: 99%

Asset Pricing and Monetary Policy

Dong

2013

SSRN Journal

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This paper examines the role of money in understanding the behavior of asset prices and whether and how monetary policy should react to asset prices such as stock prices and equity premiums. To do so, I introduce money via the form of transaction cost into a production economy with limited stock market participation where agents with lower inter-temporal elasticity of substitution (IES), called non-stockholders, have no access to stock market. In addition to facilitating transactions of consumption goods, money also redistributes wealth by countercyclically transferring resources from stockholders to non-stockholders, the main role of non-state contingent bonds. The benchmark model resolves quantitatively the risk premium puzzle and the risk-free return puzzle, matches macroeconomic behavior such as volatilities of output, consumption and investment, and is in line with empirically documented facts about money growth, inflation and asset prices in literature. This model is then used to evaluate alternative policies for money growth rates. I find that monetary policies are welfare improving for both stockholders and non-stockholders if they reduce equity premiums in the economy. These policies include a lower expected money growth, a pro-cyclical money growth rate, and growth rates of money being positively reacting to equity prices or equity premiums, all of which enhance the precautionary saving role of money.

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The equity premium and inflation

Cited by 5 publications

References 7 publications

The Equity Premium and Inflation: Evidence from the US

The Equity Premium and Inflation: Evidence from the US

A systematic test for myopic loss aversion theory

Asset Pricing and Monetary Policy

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