Analysis On The Effects Of Inflation On China’s Stock Market Retur

Since the second half of2007, China’s economy has entered a new cycle of inflation. In face of this persistent inflation, as one of the most familiar investment tools, will stock deal with the impact of inflation? The well-known economist Fisher said:nominal interest rate will adjust itself to the impact of expected inflation rate, the relationship between nominal interest rate and the general price level is positive at the long run, however, the actual interest rate is determined by real economic activity, which generally does not change, it can be regarded as constant. Extended to the stock market, nominal rate of stock return and the inflation rate should be a one-to-one positive relationship, but the actual stock return is not subject to inflation. Will Fisher Effect hold on China stock market? In this paper, we selected the monthly and quarterly data from2000to2012to research on the impact of inflation to stock return.This paper is divided into five parts. Chapter1introduces the research background, significance, article structure, as well as innovations and deficiencies. Chapter2introduces theories about inflation, the Fisher effect and several famous hypotheses, then several transfer theories between stock return and inflation. Chapter3contains empirical analysis test on the relationship between stock returns and inflation. First we do ADF stationary test for each variable, then we find that Fisher effect does not hold by the regression between actual stock return and inflation. Then we use H-P filter and ARIMA method to decompose the inflation into expected and unexpected inflation, after regression, we get the final conclusion-Fisher Effect does not hold on China’s stock market. On this basis, we test three most influential hypotheses to interpret the Fisher Effect Paradox, with GARCH included. Chapter4contains a VAR model based on the four variables, which confirms our results again. Chapter5summarizes the conclusions and offers some policy advices.I get the conclusion from the paper that Fisher effect does not hold on China’s stock market, stock can not hedge the lost from inflation. The Proxy hypothesis and the Volatility Hypothesis can not explain the negative correlation between stock return on China’s stock market and the inflation rate, changes of the money supply causes this. In the VAR model, we set the correlation matrix, then we do the Granger test, we find a one-way causal relationship between inflation and stock return:inflation is a Granger causality to stock return, however, stock return is not a Granger causality to inflation, which also shows the pathways referred in the financial market do not hold. The impulse response analysis further confirms the above conclusions.