Extracting Inflation from Stock Returns to test Purchasing Power Parity

Bhagwan Chowdhry, Richard Roll and Yihong Xia

University of California at Los Angeles, Anderson Graduate School of Management from Anderson Graduate School of Management, UCLA

Abstract: We provide a novel method for extracting estimates of realized pure price inflation from stock returns. The key is recognizing that pure price inflation should a®ect nominal returns of all traded assets by exactly the same amount. The popular Fama- French three-factor model is employed to purge stock returns of real economic factors. We uncover evidence that purchasing power parity holds quite well using the extracted inflation measures.

Date: 2002-06-20
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