Academic journal article Journal of Economics and Finance

Are Common Stocks a Hedge against Inflation in Emerging Markets?

Academic journal article Journal of Economics and Finance

Are Common Stocks a Hedge against Inflation in Emerging Markets?

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1Introduction

Since the Great Inflation, which lasted from 1965 to the mid-1980s, academics and practitioners have been quite concerned about the inflation-hedging property of common stocks. That common stocks should have the ability to hedge against inflation is a proposition that is typically rationalized on the grounds that common stocks represent residual ownership of physical production facilities whose values increase with rising prices (inflation). Over the last five decades, a large body of theoretical and empirical work has accumulated in the literature to test the validity of the inflation hedging capability of common stocks.1 A common feature of this work is that it explores the relationship between nominal returns on the underlying assets and inflation in the context of the Fisher hypothesis such that if the hypothesis holds, then the prices of these assets should move in a one-to-one positive relation with goods prices and, as a consequence, the expected nominal returns on them will be equal to expected inflation rates over time. However, results emerging from this work have generally been inconclusive, giving rise to controversy among researchers about both the validity of the underlying hypothesis and the inflation-hedging ability of common stocks.

One implication of the invalidity of the Fisher relation is that real returns on financial assets such as common stocks are unlikely to be independent of inflation rates, eventually resulting in non-neutrality of monetary policy. In reality, this hypothesis is one of the building blocks of the new classical macroeconomic model stating that over the long run, inflation is driven exclusively by the monetary growth, and as such, real return and output levels tend to return to their natural levels determined by real (nonmonetary) forces. The second implication is that monetary authorities are unable to control inflation by reducing nominal interest rates. The third implication is that the inability of financial assets to hedge against inflation creates uncertainty across financial markets, thereby adversely affecting investment and saving decisions in an economy. The final implication is that investors around the world are unable to improve the inflation protection properties of their equity investment portfolios through global portfolios, since inflation seldom affects all regions of the world at the same time.

The objective ofthis paper is to examine the inflation-hedging ability of common stocks for emerging market countries by examining the proposition embedded in what is termed "the generalized Fisher hypothesis" (GFH) in that stock prices should move positively in a one-to-one relation with goods prices and, hence, expected nominal returns on stocks will be equal to inflation rates over time. The motivation for reinvestigating the inflationhedging ability of common stocks for emerging market countries goes as follows. First, historically high average expected returns and volatility of equity stocks have attracted the attention of many researchers (among others, Barnes et al. 1999; Choudhry 2001; AlKhazali and Pyun 2004; Alagidede 2009; Alagidede and Panagiotidis 2010) to testing how the GFH performs for the stock markets of emerging market countries and whether emerging equity markets protect their investors against inflation. Second, new equity markets of the emerging market countries have provided the world's investors with a larger and an increasingly important set of investment opportunities for global portfolio diversification (Harvey 1995).2 Third, in fact, inflation risk has been relatively more intense in emerging market countries than in developed countries, since inflation has always been much higher in these countries due to higher interest rates and food prices on the one hand and the much greater importance of food and stronger economic growth rates on the other hand (Amenc et al. 2009). …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.