This book dwells on a specialized subject matter in corporate and macro finance which is the theoretical and empirical association between inflation, inflation variability, and stock returns. The analysis, while being mainly applied to the experience of the United States of America, covers also the international evidence. The major intent is to gather statistical proof for the hypothesis of inflation irrelevance. The theoretical underpinning is that a stock price is the present value of its pertinent future cash flows, discounted by an appropriate interest rate. The cash flows and the discount rate can be either in nominal or in real terms, i.e. adjusted for inflation. The only requirement is for the investor to be consistent and to use nominal cash flows with a nominal discount rate, or, alternatively, and equivalently, real cash flows with a real discount rate. Although the major part of the book considers the relation between the inflation rate and market stock prices, inflation variability is examined as well. In this regard, there is a widespread notion that a higher inflation is coupled with more inflation uncertainty. Hence high inflation variability is expected to have an impact on both nominal cash flows and on nominal discount rates. The inflation irrelevance proposition generalizes to an inflation variability irrelevance, which is its corollary.
The book is strongly applied in nature. As such there is a substantial usage of econometric techniques, and most of the book is devoted to analyze the econometric findings. Bivariate and multivariate models, simple and multiple regressions, panel and system functional forms, single and joint relations, constrained and unconstrained equations, robust least squares, and quantile specifications, dynamic and static methods, and linear and non-linear effects, are all in the contributing menu. Nonetheless and above all, there is a solid and intuitive theoretical framework for stock prices. An additional and related viewpoint that permeates in the book is that a bivariate relation between inflation and stock returns, or inflation variability and stock returns, suffers from an omitted variable bias that produces a spurious result. When the relation is augmented by fundamentals the influence of inflation, and of inflation variability, loses its statistical significance and ultimately is dissipated.
The book may not be suitable to the general public. To the contrary, the book is designed to appeal to a restricted audience, consisting primarily and basically of graduate and post-graduate students. The book is especially opportune and handy for schools and universities that privilege an applied approach to economics. Even so the book should be accessible to investors, policy-makers, and any other stakeholders who watch the financial market and try to make sense out of it. Presently inflation is a hot item in the economic discourse. And the behavior of stock markets is closely observed by many. Hence the underlying proposition of inflation irrelevance is not only topical but trendy. More people than intended may be interested, especially because the working proposition is simple, easy to understand, and has a broad repercussion on both the macro-economy and the micro-economy.
The general conclusion from my whole investigation is that inflation and inflation variability are indeed irrelevant and neutral to stock prices. This finding, which is reached by a sound theoretical and empirical approach, has a profound and consequential implication for monetary and financial markets, on one hand, and for the real economy, on the other hand.
