Relationship between stock returns and inflation: New evidence from the US using wavelet and causality methods

Aviral Tiwari, Adeolu O. Adewuyi, Olabanji Awodumi and David Roubaud

International Journal of Finance & Economics, 2022, vol. 27, issue 4, 4515-4540

Abstract: This study examines the relationship between stock returns and inflation in the United States from 1800 to 2017 using wavelet techniques, complemented with linear and nonlinear causality approaches. Wavelet analysis shows evidence of weak co‐movement between stock returns (real and nominal) and inflation in the short run and strong co‐movement between them in the long run. A movement towards the long run increases the strength of co‐movement between the two variables. Analysis based on annual data and time domain indicates unidirectional causality running from nominal stock returns to inflation using both linear and nonlinear causality tests. However, causality between real stock returns and inflation vary depending on the tests employed. Time‐scaled analysis shows that irrespective of the causality tests, a feedback relationship exists between stock returns (nominal and real) and inflation at the intermediate and long time scales. Results based on monthly data for time domain show bidirectional causality between stock returns (nominal and real) and inflation using both linear and nonlinear causality tests. Analysis by frequency bands reveals that, irrespective of the causality tests, stock returns (both nominal and real) have no link with inflation in the short to medium term. Some important policy implications are derived from the foregoing findings.

Date: 2022
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