Unexpected inflation, inflation uncertainty, and stock returns

Kiseok Lee

Applied Financial Economics, 1999, vol. 9, issue 4, 315-328

Abstract: This paper advances a hypothesis that the negative correlation between ex post real returns and unexpected inflation is induced by the negative correlation between ex post real returns and the uncertainty premium. The hypothesis is based on an uncertainty-adjusted present value model in which future dividends are more heavily discounted as uncertainty increases. Using an economic model which suggests the time-varying dividend uncertainty is mainly driven by the time-varying inflation uncertainty, this paper presents supportive empirical evidence using two different approaches. In the first approach, parametric models are developed for the conditional variance of inflation and its associated uncertainty premium. The results show that both conditional variance and uncertainty premium are negatively correlated with real returns, and their negative correlations dominate the negative correlation between unexpected inflation and real returns. The second approach uses a regression model in which frequency components of unexpected inflation are used as indicators of varying degrees of inflation uncertainty. The regressions reveal that the higher the uncertainty associated with a frequency component of unexpected inflation, the stronger the negative correlation with real returns.

Date: 1999
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www.tandfonline.com/doi/abs/10.1080/096031099332203 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:taf:apfiec:v:9:y:1999:i:4:p:315-328

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/RAFE20

DOI: 10.1080/096031099332203

Access Statistics for this article

Applied Financial Economics is currently edited by Anita Phillips

More articles in Applied Financial Economics from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().