Inflation in international markets, Financial Management

Inflation in International Markets

In 1983, Gultekin tried to find out the relation between stock return and the inflation rates (expected/unexpected). He accomplished this by regressing the return of 14 local stock markets against expected and unexpected inflation as given by the time series model. The results of this study indicated a negative relation between stocks return and unexpected inflation in 7 countries. In Canada, Italy, Switzerland and the United States, a significant negative relation was observed. But each of the countries other than the United States indicated only half of the negative relations that were observed in the US. In case of the UK, the relation is significantly positive, which can be attributed to positive effect from oil inflation due to North Sea petroleum discoveries of the UK and the strong influence of import prices on its inflation rate. Interestingly, all these international conclusions obtained by conducting research between stock market return and inflation rate are more uncertain than the results found for the United States. This could be possible because of the different relations between the corporation and labor, and differences in tax rules. In most of the countries, only one set of books is used for reporting and tax purposes. In the United States, income generated by corporations are taxed twice, once at the corporate level and again at the personal level when dividends are received. The twice taxing phenomenon for the inflated dollars may be a cause for the US markets to be more responsive to inflation rates than any other markets.

In 1988, Solnik presented some contrary evidence, arguing that prior to free floating exchange rates, there were no independent monetary policies and different independent inflation rates were observed across countries. He concentrated his study on the post-Bretton Woods period and used interest rates as proxy for the inflation rates. He showed (as indicated in Table 3) a strong negative relationship between changes in interest rates and real returns generated for all the eight countries studied assuming the constant level of interest rates. Undoubtedly, if interest rates and inflation expectations in the international market are strongly related, a strong support will come to positive relationship observed in the United States between changes in inflation expectations and stock market returns.

 

Posted Date: 9/11/2012 4:56:26 AM | Location : United States







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