Stock returns and inflation: a new test of competing hypotheses

Abstract

In this paper, an unrestricted cointegrating VAR is employed to test the dynamic implications of three competing explanations of the negative stock return-inflation relationship. Test results are provided which make use of recent advances in testing for Granger-causality. One implication is that Granger-causality testing using the newly recommended procedures results in a different interpretation of the links between inflation and stock returns. It is also found that Geske and Roll's is the only theory with a dynamic structure that is not rejected by a sample of quarterly US data from 1960 to 1992, although results are not entirely inconsistent with Fama's proxy hypothesis. Only Benderly and Zwick's hypothesis is clearly rejected by the data. The results also provide stylized facts on the dynamics linkages among key macroeconomic variables.

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