Abstract:
The theoretical underpinning for inflation and stock market returns nexus comes largely from the work of Irving Fisher who postulated that stock market returns act as a hedge against inflation. There is the generally held view that expected nominal stock market returns consists of an expected real returns and a compensation for inflation. The need to bring this issue home to Nigeria motivated this study. This study chose a broad objective of examining the causal relationship between inflation and stock market returns with evidence from the Nigerian economic environment. The study adopted the ex-post facto research design, and monthly time series data for a thirty-year period 1985- 2014 were collated from the Central Bank of Nigeria’s annual reports and statistical bulletin. Six hypotheses were proposed and tested. The Ordinary Least Square (OLS) regression, Granger Causality Test, Cointegration (Engle and Granger as well as Johansen Rank Test), Error Correction Model were used to test the hypotheses. The stock market returns represented by All Share Index (ASI) was used as the dependent variable while lagged inflation, expected inflation, unexpected inflation and contemporaneous inflation were used as independent variables respectively. It was found out that All share Index showed a negative but significant response to Lagged and Contemporaneous inflation while expected and unexpected inflation proved to be a positive and significant functions of stock market returns. Bidirectional causality exists between stock market returns and expected and unexpected inflation respectively while no causal relationship was found between stock market returns and contemporaneous inflation and lagged inflation respectively; and a long run cointegrating relationship was found between stock market returns with a speed of adjustment of 61% shown by the Error Correction Term. It was also discovered from the sub sample tests that inflation stock market nexus in Nigeria is affected by time and data frequency. It is recommended that efficient policies in the areas of improved macroeconomic and regulatory environment should be made to make the stock market stable, enhance returns as well as control risk, of which inflationary pressure is one.