Faculty of Economics and Business Administration Publications Database

Expected Inflation, Expected Stock Returns, and Money Illusion: What can we learn from Survey Expectations?

Schrimpf, Andreas
Volume: 55
Number: 5
Pages: 702 - 719
Month: June
ISSN-Print: 0014-2921
Link External Source: Online Version
Year: 2011
Keywords: Inflation expectations; Money illusion; Proxy hypothesis; Return predictability

We show empirically that survey-based measures of expected inflation are significant and strong predictors of future aggregate stock returns in several industrialized countries both in-sample and out-of-sample. Empirically discriminating between competing sources of this return predictability by virtue of a comprehensive set of expectations data, we find that money illusion seems to be the driving force behind our results. Another popular hypothesis – inflation as a proxy for aggregate risk aversion – is not supported by the data.