Are common stocks a good hedge against inflation :|bevidence from India and China

Abstract

This thesis provides empirical evidences on the relations of stock prices and goods prices of China and India in country level and industry level. We find negative short run relation between real stock returns and inflation in India where Fama’s proxy hypothesis couldn’t explain it; while independent stock-inflation relation in China, consistent with Fisher’s hypothesis. Moreover, we extend the investigation to long run relation of stock-inflation using a framework of tax-augmented Fisher hypothesis. Most pairs of stock and goods prices are cointegrated except 2 pairs in 31 pairs. The elasticity of stock prices to goods prices are significantly above unity in all pairs but 3. These findings, though in sharp contrast to most existing findings that report price elasticity of below unity or even no long run relation, appearing theoretically more plausible because nominal stock returns must exceed the inflation rate to compensate tax-paying investors. The time path test reinforce that India stock-inflation relation adjust from negative to positive over time, whereas China stock prices persists positive response to the corresponding shocks in consumer price indexes. The findings of inflation components also enhance the above findings. Hence, even though the time span is varying across countries, market segmentations and industries, stock portfolios are a reasonably good hedge against inflation in the long run in China and India.