Stock returns and inflation in Pakistan

- The nexus between stock returns and inflation is assessed at different frequencies for Pakistan.
- The results of frequency based causality provide preliminary evidence on the interdependence of stock returns and inflation.
- The analysis of wavelet coherency and phase angle offers further insight into the issue.
- Suggest association between the variables at the lower time scales or higher frequencies.
- Broadly both the measures of inflation provide evidence of long term hedging ability of stocks in Pakistan.

The nexus between stock returns and inflation is assessed for Pakistan using the methodology of frequency based causality and continuous wavelet transform over a long sample period 1961:M07-2012:M02. The preliminary investigation using the frequency based causality suggests interdependence of stock return and inflation. Our deeper investigation using the tools of wavelet coherency and wavelet phase angle in the continuous wavelet transform framework, however, explore dependency between stock returns and inflation over certain time periods; especially for lower time scales. For higher time scales, the study finds stock returns and inflation to be in the phase (positively related) when consumers' price inflation is considered and independent when producers' price inflation is utilized. Overall results based on both the inflation measures indicate that, inflation does not erode the value of stocks in Pakistan and stocks could be used as hedge against inflation at least in the long-run.