| Abstract: | Contrary to economic theory, there is international evidence that common stock returns and inflation are negatively related. This negative relationship is examined in this paper and the applicability of the risk premium hypothesis is tested. According to this hypothesis, an increase in unanticipated inflation causes the market risk premium to rise, which in turn lowers current stock prices. A model is developed and the effect of uncertain inflation on the market risk premium across four countries is tested empirically. Results indicate that the market risk premium is positively related to uncertain inflation. |
