Stock prices, inflation and inflation uncertainty in the U.S.: Testing the long-run relationship considering Dow Jones sector indexes

TL;DR

This study investigates the long-term and short-term relationships between U.S. stock prices, inflation, and inflation uncertainty across different sectors, revealing negative long-run effects and sector-specific dynamics influenced by the 2008 financial crisis.

Contribution

It introduces a cointegration analysis with a structural break and a time-varying model to assess inflation uncertainty's impact on sector stock prices, highlighting the effects of the financial crisis.

Findings

Long-run negative impact of inflation and uncertainty on stock prices.

Post-crisis, the negative effects diminish for several sectors.

Short-run, inflation uncertainty negatively affects stock prices, but inflation's impact is limited.

Abstract

We test for the long-run relationship between stock prices, inflation and its uncertainty for different U.S. sector stock indexes, over the period 2002M7 to 2015M10. For this purpose we use a cointegration analysis with one structural break to capture the crisis effect, and we assess the inflation uncertainty based on a time-varying unobserved component model. In line with recent empirical studies we discover that in the long-run, the inflation and its uncertainty negatively impact the stock prices, opposed to the well-known Fisher effect. In addition we show that for several sector stock indexes the negative effect of inflation and its uncertainty vanishes after the crisis setup. However, in the short-run the results provide evidence in the favor of a negative impact of uncertainty, while the inflation has no significant influence on stock prices, except for the consumption indexes. The consideration of business cycle effects confirms our findings, which proves that the results are robust, both for the long-and the short-run relationships.