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  3. American Economic Review
  4. March 2005
  5. Extracting Inflation from Stock Returns to Test Purchasing Power Parity

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Extracting Inflation from Stock Returns to Test Purchasing Power Parity

  • Bhagwan Chowdhry
  • Richard Roll
  • Yihong Xia
American Economic Review
vol. 95, no. 1, March 2005
(pp. 255–276)
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Abstract

Relative purchasing power parity (PPP) holds for pure price inflations, which affect prices of all goods and services by the same proportion, while leaving relative prices unchanged. Pure price inflations also affect nominal returns of all traded financial assets by exactly the same amount. Recognizing that relative PPP may not hold for the official inflation data constructed from commodity price indices because of relative price changes and other frictions that cause prices to be "sticky," we provide a novel method for extracting a proxy for realized pure price inflation from stock returns. We find strong support for relative PPP in the short run using the extracted inflation measures.

Citation

Chowdhry, Bhagwan, Richard Roll, and Yihong Xia. 2005. "Extracting Inflation from Stock Returns to Test Purchasing Power Parity." American Economic Review, 95 (1): 255–276. DOI: 10.1257/0002828053828554

Additional Materials

JEL Classification

  • E31 Price Level; Inflation; Deflation
  • F31 Foreign Exchange