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PLAGIARISM
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PUBLICATIONS
Although several papers have examined this issue, there is still a lack of consensus on the nature of the relationship between return on equity and inflation. Recent literature has raised the issue of asymmetric adjustment, including analysis of the relationship between capital return and inflation.
INTRODUCTION
Introduction
Similarly, the potential for variation in the relationship over time, and therefore the ability of stocks to act as an inflation hedge, is another factor that has been taken into account in more recent literature (Bhanja and Dar, 2018). These issues, to the best of the author's knowledge, have yet to be addressed in the South African context.
Problem Statement, Research Questions and Objectives
Accounting for these assumptions significantly improves the power of the econometric analysis and provides a significant robustness improvement when considering the stock return-inflation relationship in South Africa. In providing an analysis of each of these issues within the scope of the broader research problem, four empirical papers are presented.
Plan of the Thesis
Finally, a concluding chapter is presented (Chapter 8) which summarizes the combined results of the thesis and discusses potential avenues for further research. By way of a brief summary of the most important contributions of this study, it was concluded that stocks have historically acted as an effective long-term hedge against positive inflation in South Africa.
THE THEORETICAL UNDERPINNINGS OF THE EQUITY
Introduction
Financial Valuation Methods
- Discounted Cash Flow Analysis
- Net Present Value (NPV)
- The Dividend Discount Model (DDM)
- Free Cash Flow (FCF)
It states that the total value of a company is equal to the sum of the current values of all its future projects. The NPV equation assumes that a company has accurate knowledge of the value of all cash flows from all projects that will be undertaken in the future.
Valuation Under the Effects of Inflation
This decrease in the NPV of the investment due to the inability to increase the cash flows in line with the increase in the discount rate means that the real rate of return on the investment would be negatively affected by inflation, ultimately excluding the investment as an effective inflation . hedge, consistent with Fama's (1981) hypothesis discussed later in this chapter. However, if the firm is able to increase cash flows to offset the inflationary effect on the discount rate, tied up capital will then function as an effective inflation hedge.
Criticisms of the Neutrality Assumption
However, the denominator in the equation, which is a function of the discount rate, increases due to inflation, causing the denominator to increase. In the more extreme case, it is possible for inflation and cash flows to have negative elasticity for several reasons (Farsio and Fazel, 2008).
The Fisher Hypothesis
Barsky (1987) describes the Fisher Hypothesis as one of the cornerstones of neoclassical monetary theory, and states that the Fisher Hypothesis essentially states that the nominal interest rate must experience a "point-for-point" correlation with the expected inflation rate. however, recent empirical studies have provided new evidence of the existence of a positive relationship between the inflation rate and the nominal interest rate (Alagidede and Panagiotidis, 2010; Kim and Ryoo, 2011; Eita, 2012).
The Proxy Hypothesis
Hess and Lee (1999) state that supply shocks are a reflection of real output shocks and contribute to a negative relationship between stock returns and inflation. Demand shocks, on the other hand, are caused by monetary shocks and contribute to a positive relationship between stock returns and inflation.
An Introduction to Cointegration
Should it turn out that the series in the regression is nonstationary but integrated in the same order, i.e. in this case all linear combinations of the series would be nonstationary and therefore the series would not be cointegrated (Brooks, 2008 ).
A CHRONOLOGICAL REVIEW OF THE LITERATURE
The Empirical Evidence that Contributed to the Proxy Hypothesis
In Bodie's (1976) study, the author used the framework of the Markowitz-Tobin-Mean-Variance model of portfolio choice to determine the effectiveness of common stocks as an inflation hedge. The author referred to a second definition of an inflation hedge as a security with a real rate of return that is independent of the inflation rate, as used by Branch (1974), Fama and Macbeth (1974), and Oudet (1973).
Mayya (1977)
Ten of the subgroups experienced increases in value during the period, but of an order of magnitude less than the wholesale increase in the price level, resulting in a partial hedge against inflation. It is interesting to note that although stocks on an aggregate level were generally ineffective as a hedge against inflation, investing in a specific portfolio of stocks would have produced an increase in the value of the stocks greater than the rate of inflation.
Firth (1979)
However, in certain years during this period, the value of equity securities increased by more than the rate of inflation, which actually acted as more than a hedge and actually provided an additional return on equity investments. This index is estimated as an equally weighted geometric mean of the returns of thirty major stocks.
Gultekin (1983a)
The generalized Fisher hypothesis assumes market efficiency and that the expected real stock returns and the expected inflation rate can fluctuate independently, meaning that aggregate investors will be compensated for exogenous adjustments of purchasing power. In addition, this value of 𝛽 approaching unity is consistent with the assumption that expected stock returns and the expected inflation rate fluctuate independently.
Gultekin (1983b)
Gultekin (1983b) notes that the expected real return on stocks is subject to variation over time but maintains a positive aggregate relationship with inflation. In conclusion, Gultekin (1983b) determined that the expected real return on common stocks is subject to inconsistency over time and is positively related to expected inflation.
Day (1984)
Day (1984) found that the expected inflation rate varied inversely with the direction of the unexpected random shock, while the expected real return varied in the same direction. This implies a negative relationship between the expected inflation rate and the expected real return in the model.
Prabhakaran (1989)
This has a positive effect on the expected supply of goods, resulting in a decrease in the expected rate of inflation due to the inverse relationship between the supply of goods relative to the expected money supply. On the other hand, stock prices experienced decreases in four of the years included in the data set and increases in prices in the remaining years.
Claude, Campbell and Viskanta (1995)
In 5 of the 12 years, the authors found that the probability of stock price appreciation increased over the time period between the studies with market developments and would thus provide a hedge against inflation in 6 of the 15 years included in Prabhakaran's (1989) study. The authors conclude that their analysis of the interaction between inflation and the time series of expected returns in sample markets yielded evidence of a negative time series relationship between realized inflation and realized asset returns when countries were examined individually (Claude et al., 1995). .
The Transition to the Application of Cointegration Techniques
- Ely and Robinson (1997)
- Khil and Lee (2000)
- Moolman and du Toit (2005)
- Kasman, Kasman and Turgutlu (2006)
- Hancocks (2010)
- Alagidede and Panagiotidis (2010)
- Kim and Ryoo (2011)
- Eita (2012)
- Khumalo (2013)
To determine the nature of the relationship between stock market returns and inflation rate, Eita (2012) used Johansen's approach and VECM. Based on the results of the unit root tests, Khumalo concludes that stock prices are I(0) while inflation is I(1).
Conclusion to the Literature Review
Furthermore, it has been seen, based on Hancocks (2010) that modeling the relationship together with a variety of additional macroeconomic variables may provide an inaccurate assessment of the relationship as the results obtained were much larger than the limits of realistic expectations. Each of the following chapters attempts to address these previous conflicting findings in order to provide a strong conclusion on this issue in the South African context.
EQUITIES AS A HEDGE AGAINST INFLATION IN SOUTH AFRICA
Introduction
Original Contribution
The advantage of the latter model is that it is able to take into account different orders of integration of the variables (it can determine the magnitude of the relationship, regardless of whether the variables are stationary or non-stationary in level terms). Furthermore, the results of the original VECM are more easily comparable with international studies that used the same technique.
Paper as Published in the African Review of Economics and Finance (AREF)
The β coefficient in the above equation represents the magnitude and nature of the relationship between stocks and inflation. The results of the ARDL cointegration equation provide evidence in support of a cointegrating relationship between stock prices and inflation.
Statement of Author Contribution
Conclusion
This idea of low power of the unit root tests is explored and tested thoroughly in Chapter 5, which considers unit root tests in the presence of structural breaks and regime shifts, consistent with the work of Gregory and Hansen (1996a,b). The baseline ratio determined by ARDL is more comparable to expectations in the Fisher hypothesis extended to account for tax effects, with the overall conclusion being that equities have acted as an effective hedge against inflation in South Africa.
INVESTIGATING TEMPORAL VARIATION IN THE EQUITY
Introduction
Original Contribution
The possibility that the cointegration relationship has undergone a change due to inflation targeting and structural changes in the market during the apartheid transition is theoretically plausible and would likely have important implications for any conclusions drawn from cointegration tests of the relationship. If changes in relationship magnitude are evident before and after a significant breakup, this would have important implications for the conclusions drawn regarding a long-term relationship.
Paper as Published in the African Journal of Business and Economic Research
Consequently, a separate body of literature has developed to test for the possibility of a change in the relationship. Next to this, the number of delays included in the model and the estimated date of the interruption are presented.
Statement of Author Contribution
Conclusion
The results illustrate that the relationship experiences volatility over time, proving that the assumption of time invariance is probably flawed – which may have had a far greater effect on the conclusions drawn from the results of international studies. Due to the fact that the relationship has been found to vary over time, it is worth considering that threshold effects may have occurred in the relationship.
ACCOUNTING FOR THRESHOLD EFFECTS AND ASYMMETRIC
Introduction
The study is limited by the use of a short data set, and the power properties of the model are therefore not ideal. However, the findings help highlight that the issue of asymmetric adjustment may well extend to the relationship between stock returns and equity returns. inflation.
Original Contribution
Kim and Ryoo (2011) used a two-regime threshold vector error correction model (TVECM) to test for cointegration in the context of the return on equity–inflation relationship. Thus, the null hypothesis of no cointegration can be rejected, accepting the alternative hypothesis of threshold cointegration.
Conclusion
This statement serves to confirm that the paper presented in Chapter 6 of this thesis "Equity as a hedge against inflation in South Africa" is the PhD candidate's own original work, as stated in Statement 2: Publications. AN ANALYSIS OF THE NONLINEAR DYNAMICS OF THE CAPITAL RETURNS-INFLATION RELATIONSHIP IN THE SOUTH.
Introduction
The second objective, if the relationship is found to exhibit evidence of asymmetric adjustment, is to identify the magnitude of the positive and negative adjustment coefficients. Such a breakdown is, to the author's knowledge, the first application of its kind in the context of the analysis of stocks' ability to act as an inflation hedge, both nationally and internationally.
Original Contribution
By disaggregating the β-coefficient, which has been the focus of the previous studies in the literature, one is able to handle shifts in the inflation rate much more effectively, especially in cases where the positive and negative adjustment coefficients differ substantially. To the best of the author's knowledge, no such study has been done in this context so far.
Paper Presented as Prepared for Submission to the Investment Analysts Journal (IAJ). -
While much of the international data explicitly suggests that the data consisting of nominal stock returns and inflation (usually represented by CPI) is non-stationary when conventional unit root testing is used to examine the order of integration of the variables, it was not consistently the case in South Africa, discussed in detail by Arnold and Auer (2015). 𝐿𝑜𝑔𝑆𝑃𝑡= 𝐶 + 𝛽+∆𝐿𝑜𝑔𝐶𝑃𝐼𝑡 𝑃𝑜𝑠 − 𝛽−∆𝑐 𝑁𝑒𝑔 + 𝜀𝑡 (1) Here the 𝛽+ and 𝛽− coefficients represent the size of the positive and negative adjustment coefficients respectively.
Conclusion
While the correlation was positive in the case of the positive adjustment coefficient, indicating that stocks effectively act as a hedge against positive inflation variations, the results indicated that negative inflation variations have a much more positive effect on stock returns. It is suggested that in case of future research, examine the disaggregated components instead of the aggregated adjustment coefficient, to better understand the dynamics of the cointegrating relationship.
CONCLUSIONS
Summary of Findings
This would help to explain some of the different results in the previous literature that considered different time periods. The difference in the size of the coefficients has important consequences for both policy makers and investors.
Limitations of Study and Areas of Future Research
A possible limitation in the early studies could be the effect of over-differentiating the sequences when stationarying them. In terms of modeling extensions, there are several approaches that could provide an interesting look at the dynamics of the relationship.
Conclusions and Summary of Original Contributions
To clarify, before using the Zivot-Andrews (1992) test, an ADF approach is used to determine k based on the Akaike Information Criterion (AIC). The results of the Zivot-Andrews (1992) test show that each set contains at least one unit root and therefore the relationship cannot be tested using a simple OLS framework in case of the possibility of spurious regression (Gujarati and Porter, 2009).
