STOCK RETURNS, INFLATION, AND THE PROXY HYPOTHESIS - A NEW LOOK AT THE DATA

This paper reexamines the proxy hypothesis of Fama (American Economic Review, 1981, 71, 545-565) as the main explanation for the negative co rrelation between stock returns and inflation. We look at quarterly da ta on industrial-production growth, monetary-base growth, CPI inflatio n, three-month Treasury-bill rates, and returns on the equally-weighte d NYSE portfolio, for the 1954-1976 and 1977-1990 periods. Using time- series techniques, we find that production growth induces only a weak negative correlation between inflation and stock returns, and explains less of the covariance between the two series than inflation and inte rest-rate innovations.