Empirical Analysis of Effects of Expected Inflation on Stock Returns
Author: Farwa Abbas

Existing studies in Pakistan analysed the relationship among inflation and stock returns by adopting concluded a negative correlation. In current study, we adopted asymmetric test specification model to examine the impact of expected inflation on stock returns. While to calculate expected inflation, two methods including Fama money demand model (1981) and ARMA model were employed. We calculated expected inflation through integration of aforementioned models and in sample/iterative, in-sample/non iterative and out of sample/iterative methods. Further, study uses regression to get expected inflation filtered from errors and the fitted values were utilize to filter out errors. The study was divided into sub samples of low and high inflations time periods. In order to divide them in high and low inflation time period the dummy variable were used and the average of inflation was taken as threshold level. Impact of expected inflation on stock returns is analysed by differently calculated expected inflation in order to confirm their results or to see whether there is any difference between their results. Monthly data is obtained covering data span of August 1998 to June 2017 from concerned sources. The result shows a strong relationship between real stock returns (adjusted from inflation) and expected inflation while utmost an insignificant relationship between nominal stocks returns and expected inflation. A negative relationship is noticed between stock returns and inflation during only low inflation time period in contrast to high inflation time period (positive relationship). Nevertheless, in both cases stocks are providing a good protection against inflation. The impact of expected inflation on stock returns by dividing the sample period into sub periods provides insignificant relationship between stock returns and expected inflation which is obvious as stock returns behaves noisy in short time period. Supervisor:- Dr. Ahsan ul Haq

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Supervisor: Ahsan ul Haq Satti

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