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Article

The Impact of Expected and Unexpected Inflation on
Local Currency and U.S. Dollar Returns from Foreign Equities

Haim A. Mozes and Serge Cooks
The Journal of Investing Summer 2011, 20 (2) 15-23; DOI: https://doi.org/10.3905/joi.2011.20.2.015
Haim A. Mozes
is a senior quantitative consultant at Spring Mountain Capital, LP, and an associate professor of accounting at Fordham University Graduate School of Business in New York, NY.
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  • For correspondence: hm@smcinvest.com
Serge Cooks
is a quantitative research analyst at Spring Mountain Capital, LP, in New York, NY.
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  • For correspondence: scooks@smcinvest.com
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Abstract

This article examines the impact of inflation on stock returns. We find that inflation that is expected is significantly positively related to local currency equity market returns while inflation that is unexpected is significantly negatively related to local currency equity market returns. In addition, our estimates show that unexpected increases in inflation have a negative impact on equity returns during the year that inflation increases unexpectedly, but a positive impact on subsequent years’ equity returns. The rationale is that the current years’ unexpected inflation becomes subsequent years’ expected inflation. With respect to the impact of inflation on a country’s FX rate relative to the U.S.dollar, we find that inflation that is expected is significantly negatively related to the local currency’s performance versus the U.S. dollar, while inflation that is unexpected is significantly positively related to the local currency’s performance versus the U.S. dollar. In the aggregate, after combining local currency equity market returns and FX returns, we find that countries with higher expected inflation tend to experience higher equity returns in U.S.dollar terms and that countries with higher unexpected inflation tend to experience lower equity returns in U.S.dollar terms. The results imply that U.S. investors should seek to invest in foreign countries with either high but stable inflation or with declining inflation.

  • Copyright © 2011 Spring Mountain Capital, LP. All rights reserved. Not to be reproduced of redistributed without permission.
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The Journal of Investing: 20 (2)
The Journal of Investing
Vol. 20, Issue 2
Summer 2011
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The Impact of Expected and Unexpected Inflation on
Local Currency and U.S. Dollar Returns from Foreign Equities
Haim A. Mozes, Serge Cooks
The Journal of Investing May 2011, 20 (2) 15-23; DOI: 10.3905/joi.2011.20.2.015

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The Impact of Expected and Unexpected Inflation on
Local Currency and U.S. Dollar Returns from Foreign Equities
Haim A. Mozes, Serge Cooks
The Journal of Investing May 2011, 20 (2) 15-23; DOI: 10.3905/joi.2011.20.2.015
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  • Article
    • Abstract
    • METHODOLOGY
    • RESULTS
    • SENSITIVITY ANALYSIS
    • INFLATION EFFECT FOR SMALLER VS. LARGER STOCKS
    • FURTHER ANALYSIS OF UNEXPECTED INFLATION
    • SUMMARY AND CONCLUSIONS
    • ENDNOTES
    • REFERENCES
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