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Abstract
This paper attempts to empirically examine the Reverse Causality hypothesis within the Nigerian context during the period 1980 - 2011. Employing Vector Error Correction Methodology (VECM), causality was found between inflation and government stocks, with causality running from government stocks to inflation, thus providing evidence in support of the reverse causality hypothesis. The results from the forecast error variance decomposition (FEVD) and impulse response functions tend to further lend credence to this finding. Accordingly, this study suggests, in part, the need for a tight monetary policy which would help to reduce inflation and stock prices, as such measures would leave the individuals with less money to buy stocks. Such efforts should be complemented by augmenting domestic production and encouraging investment through inexpensive bank finance.
Keywords: Reverse causality, Stock Returns, VAR Methodology, Nigeria.
JEL Code: E3; F21; G11
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(ProQuest: ... denotes formulae omitted.)
1. Introduction
Prior to the work of Geske and Roll (1983), the conventional view of most theoretical and empirical research on the relation between returns on financial assets and inflation has been that changes in inflationary expectations was for the causative influence. In other words, stock returns were conceived to be negatively related to changes in expected inflation, at least, in the short-run (see, for instance, Jeffe and Mandelker, 1976; Nelson, 1976; and Bodie, 1976), a development which, in principle, tends to contradict the Fisherian hypothesis. Fisher (1930) hypothesized that real stock price is independent of inflation. This implies that in the regression of expected returns on expected inflation, it should possess a unity coefficient. However, most of those early empirical studies on Fisher's hypothesis were largely preoccupied with describing the nature of the relationship between inflation and stock returns and not with any explanation of the results. Since the 1980s, however, the need for a better explanation has spurred a number of alternative hypotheses, such as the tax effect hypothesis (Feldstein, 1980); proxy hypothesis (Fama, 1981); and the reverse causality hypothesis (Geske and Roll, 1983).
Empirical studies on these three hypothetical explanations using data from both the developed and emerging economies have however produced mixed results, an indication that the actual relationship between these two variables of interest is far from being certain. Specifically,...