Relationship between Inflation and Stock Market Returns: Evidence from Bangladesh

Abstract

The linkage between stock prices and inflation has been intensively investigated since the 1990s. Most of the studies in the industrialized economies have shown a negative relationship between stock market return and inflation. Thus there is considerable interest surrounding the relationship between stock markets and inflation. This paper investigates the relationship between inflation and stock market returns in Bangladesh using monthly data for the period 2004 to 2013. To test for the order of integration of the variables, ADF and PP tests were used and the results show that all the variables are integrated in the same order I(1). The Johansen test procedure confirmed that there is single cointegration equation at 5 percent significance level and thereby indicating the long run equilibrium relationship between the variables. The findings of the study have showed that the speed of adjustment in the Vector Error Correction model (VECM) is significant and relatively very high. The value of the ECM is -0.9373 which implies that, on average, the system corrects the disequilibrium errors annually by about 94%. The results also indicate that there is a uni-directional short run causal relationship between inflation and stock price index.