CHAPTER 3: A CHRONOLOGICAL REVIEW OF THE LITERATURE
3.3 The Transition to the Application of Cointegration Techniques
3.3.6 Alagidede and Panagiotidis (2010)
Index, of 14.4% per year towards the long-run-equilibrium. The findings of the negative relationship over the period between inflation and the All Share Index are consistent with the theory of the Proxy Hypothesis, in that inflation decreases asset prices, although as previously noted, the relationship determined in the study exceeds expectations by too great a factor to be consistent with the previous literature.
indicator of inflation and effectively represents the change in the price of a fixed basket of goods and services. The share price data was sourced from the International Finance Statistics and was based on the various All Share indices in South Africa, Nigeria and Kenya and the indices for the remaining countries were based on the most actively traded stocks in the countries. Monthly data over a period of 10-27 years was used because of the fact that annual data series that cover a sufficiently long period of time were simply unavailable for the sample countries. These monthly intervals were calculated using the individual consumer price indices and stock returns. The average monthly rate of inflation assumed values between 0.16% to 0.81% during the sample period, while average monthly stock returns were between 0.98% and 1.1%. A graph included by the authors is reproduced below (Figure 1) in order to emphasize the highly volatile nature of stock returns as well as inflation in African countries relative to the rates typically experienced in most European countries. The graph showing the monthly average stock returns in South Africa over the period is especially worthy of interest as it shows substantial stock returns volatility when measured using the standard deviation of stock returns.
Alagidede and Panagiotidis (2010) emphasized that there are a significant number of recent studies that reflect poor performance of the stock markets during inflationary periods.
Alagidede and Panagiotidis (2010) also pointed out that several of these studies have shown that common stocks perform poorly as a hedge against inflation in the cases of both expected and unexpected inflation. The authors began by estimating the short-term relationship between inflation and stock returns using a simple regression of stock returns on contemporaneous inflation and found that in five of the countries included in the sample there was a positive relationship between stock returns and inflation in contrast to the international data previously observed. However, the generalized Fisher Hypothesis where the β is theoretically equal to one was rejected by the Wald test in the case of five of the countries, showing that according to a regression analysis stocks did not function as an inflationary hedge, although it was noted that the model did not fit the data well based on the observation of low R2 values (Alagidede and Panagiotidis, 2010).
Figure 1: Inflation Rate and Stock Returns between 1990 and 2007.
Source: Alagidede and Panagiotidis (2010: 94)
The authors then conduct an analysis of the long-run relationship between the variables in which they began by testing for the order of integration and stationarity of the two series. To do this they used two-unit root tests, the Phillips-Perron (PP) and Breitung nonparametric test which tests for the null of a unit root and the KPSS stationarity test which tests for the null of stationarity (Alagidede and Panagiotidis, 2010). The results of the unit root tests indicated that for all of the sample countries (with the exception of Morocco which was consequently excluded) there was at least one unit root.
Subsequently, the authors conducted the Johansen's test in order to test for the presence of cointegration. Four countries showed evidence of one cointegrating vector, including Egypt, Kenya, Nigeria and Tunisia, while South Africa showed evidence of two cointegrating vectors when using Johansen’s trace test. They then employed the Breitung and Taylor (2003) test to examine potential deviations from linearity. The Breitung and Taylor nonparametric test showed that only in the case of South Africa cointegration was not rejected. The authors found that the sign of the estimated coefficient was positive and significant in South Africa as well as in several of the other sample countries, but only exceeded unity in South Africa with a value of 2.264. The lower Fisher coefficients for Nigeria, Egypt, Tunisia and Kenya (less than unity) failed to provide evidence in support of the tax-augmented Fisher Hypothesis in these countries, and as such it can be argued that aggregate investment in these markets would only have provided, at best, a partial hedge against inflation.
The Fisher coefficient in South Africa indicated a positive long-run relationship between the variables and the authors provided several reasons why this might have been the case, including the fact that over the period of this study South Africa typically maintained relatively low inflation rates, the market underwent a significant amount of development since the apartheid era after South Africa was once again included in the international community and there were a significant amount of capital inflows subsequent to the lifting of sanctions which would have had a positive effect on equity values. The authors state that although they did not possess a consistent estimate of the tax rate in South Africa, which would be necessary to determine whether investors are fully compensated for taxes as well as inflation as is conditional in the tax-augmented version of the Fisher Hypothesis, that their findings were consistent with the tax-augmented version of the Fisher Hypothesis due to the finding of unit elasticity. They are able to make this conclusion because stock returns in fact exceeded the inflation rate during the sample period, which would theoretically compensate for the loss in real wealth incurred by taxes (Alagidede and Panagiotidis, 2010).