INFLATIONS NEGATIVE EFFECTS ON REAL STOCK-PRICES - NEW EVIDENCE AND A TEST OF THE PROXY EFFECT HYPOTHESIS

The present study examines the effects of inflation on real stock prices using an error-correction model of the S&P 500. Inflation is shown to have a negative and significant impact in a variety of model specifications. The study also investigates whether the observed negative relation arises because inflation proxies for more fundamental relations between stock prices and either future output, relative price uncertainty or inflation uncertainty. The evidence reveals that inflation does not merely proxy for those other factors and, thus, the proxy effect hypothesis in its various forms is rejected.