Open AccessStock returns, inflation, and real activity in developing countries: A Markov-switching approach
Author(s) -
Atilla Çifter
Publication year - 2015
Publication title -
panoeconomicus
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.289
H-Index - 14
eISSN - 2217-2386
pISSN - 1452-595X
DOI - 10.2298/pan1501055c
Subject(s) - economics , econometrics , stock (firearms) , proxy (statistics) , markov chain , recession , inflation (cosmology) , monetary economics , macroeconomics , statistics , mathematics , mechanical engineering , physics , theoretical physics , engineering
This paper empirically investigates the relationship between real stock returns, inflation, and real activity using the Markov-switching dynamic regression (MS-DR) approach. The MS-DR allows multiple structural breaks in the estimation, and we can check regression coefficients separately in the recession and expansion periods. We selected two major developing countries (Mexico and South Africa) in order to reduce location bias. We use real stock returns, expected inflation, unexpected inflation, and real GDP growth in the estimations, and the ARFIMA model is used for unexpected inflation. The empirical results show that the relationship between real stock returns and inflation is negative only in the recession period. This regime-dependency is also tested with Eugene F. Fama’s (1981) proxy effect hypothesis, and it is found that the stock returns respond differently to inflation in a regime according to the regime-dependent proxy effect hypothesis. These findings suggest that the negative relationship puzzle in the empirical finance literature can be explained with the regime-dependency effect