Study of dynamic relationships between financial and real sectors of economies with wavelets

In this paper, we use the multiresolution wavelet-filtering technique to study the dynamic inter-relationships among the real and financial sectors of economy. We extract relationships among real stock returns, inflation and real activity for two contrasting economies, the United States and the Indian economy. We further test various existing economic hypotheses like the classical Fisherian hypothesis and the proxy-effect hypothesis of Fama using the low-frequency content part of the wavelet filtered data. The analysis reveals interesting aspects of the inter-relationship for the two contrasting economies and validity of the studied hypotheses.