Investigating Temporal Variation in the Equity Returns-Inflation Relationship in South Africa

The relationship between equity returns and inflation has been shown to be conflicting and inconsistent as well as time and country dependent. This is an issue in macroeconomics because equities are commonly regarded as a hedge against inflation. One potential explanation for the inconsistencies in the literature is the failure to account for structural breaks. This paper examines the possibility of structural breaks in both the consumer price index and stock market variables using the Zivot-Andrews (1992) and Gregory-Hansen (1996a, 1996b) procedures, which determined that the relationship exhibited evidence of structural breaks in both the individual series and in the relationship. The Fully-Modified Ordinary Least Squares (FMOLS) and Dynamic Ordinary Least Squares (DOLS) estimation procedures were employed to investigate changes in the nature of the relationship, divided by the structural break. It was concluded that the relationship is subject to temporal variation and structural breaks should be considered, but that equities have acted as a consistent inflationary hedge in South Africa.