Applied Economics Letters, 2005, 12, 871–879

The adjustments of stock prices

to information about inflation:
evidence from MENA countries
Samer A. M. Al-Rjoub
Department of Banking and Finance, Hashemite University,
PO Box 330195, Zarqa, Jordan
E-mail: salrjoub@hu.edu.jo

This study extends the empirical evidence by analysing the reaction

of monthly stock returns to the unexpected portion of CPI inflation rate
and by capturing the asymmetric shocks to volatility of unexpected
inflation in five MENA countries. Both Threshold GARCH and
Exponential GARCH are used to catch the news affect that unexpected
inflation may have on stock returns. Results document a negative and
strongly significant relationship between unexpected inflation and stock
returns in MENA countries. Results also indicate that the stock markets
of the listed MENA countries do not feel the high up and down movements
in the markets and as such the volatilities. The asymmetric news effect
is absent.

I. Introduction The present study extends the empirical evidence

An important question that has been extensively
asked in the financial economics literature is whether
nominal returns contain market assessments of
expected and unexpected inflation rates and whether
common stocks are an effective hedge against infla-
tion. However, theoretical attempts to examine the
relation between stock returns and inflation diverge.
While some studies found a significant negative
relationship between unexpected inflation and stock
returns (Bodie, 1976; Jaffe and Mandelker, 1976;
Nelson, 1976; Fama and Schwert, 1977; Schwert,
1981; Fama, 1981; Chatrath, 1997) others found
no significant relationship (Pearce and Roley, 1985;
Hardouvelis, 1987; McQueen and Roley, 1993;
Caporale and Jung, 1997). In theses studies,
unexpected inflation was created from time series
estimation of expected inflation, from the difference
between nominal interest rats and inflation, or from
experts’ predictions.
by analysing the reaction of monthly stock returns to
the unexpected portion of CPI inflation rate and by
capturing the asymmetric shocks to volatility or the
news effect of unexpected inflation. This relationship
is examined first by using Neslon and Schwert’s
(1977) first order moving average process to calculate
unexpected inflation, and second by using both
Threshold GARCH and Exponential GARCH to
catch the news affect that unexpected inflation may
have on stock returns.
Utilizing a long sample period and a time series
measures of expectations and using threshold
ARCH introduced independently by Zakoian
(1990) and Glosten et al. (1993) and Exponential
GARCH model proposed by Nelson (1991), the
interaction between the unexpected CPI inflation
rate and stock returns is examined in this article.
Section II describes the effects of unexpected
inflation on stock returns. Section III presents the
methodology and describes the data. Section IV

Applied Economics Letters ISSN 1350-4851 print/ISSN 1466-4291 online ß 2005 Taylor & Francis 871
http://www.tandf.co.uk/journals
DOI: 10.1080/13504850500365806
872
contains the EGARCH and TARCH results. Section
V concludes.
II. The Effects of Unexpected Inflation
An important question that has been extensively
asked in the financial economics literature is whether
nominal returns contain market assessments of
expected inflation rates and whether common stocks
are effective hedge against inflation. Fisher (1930)
first elaborated the hypothesis that interest rates
contain market forecasts of future inflation rates.
Economists thought that this relation could be easily
extended to common stocks and assumed that
expected nominal stock returns should adjust uni-
formly in a one to one correspondence with expected
inflation.
However there is little empirical support for
the positive inflation-return relationship and to the
commonly held view that nominal interest rates are
reliable predictors of inflation (Boudloukh and
Richardson, 1993, document positive long-horizon
returns to an actual or expected changes in inflation).
Theoretical attempts to examine the relation between
stock returns and inflation show that stock returns
are actually negatively correlated with expected and
unexpected inflation.
Indeed, typically, the coefficient of the inflation
term in a stock return equation is not only statistically
different from 1 but its sign is negative (e.g., Lintner,
1975; Bodie, 1976; Jaffe and Mandelker, 1976; Nelson,
1976; Fama and Schwert, 1977; Geske and Roll, 1983;
Pearce and Roley, 1983; Pearce, 1985). This puzzle
has been the subject of a greet deal of work in the
finance literature and several attempts were made
at explaining this puzzle (e.g., Modigliani and Cohn,
1979; Feldstein, 1980; Fama, 1981; Geske and Roll,
1983; Titman and Warge, 1989).
One of the most widely quoted explanations
are the ‘money demand proxy hypothesis’ proposed
by Fama (1981), the collective money illusion
proposed by Modigliani and Cohn (1979) and
the non-neutralities in the tax treatment of the
inventory and depreciation charges proposed by
Feldstein (1980). There are also some variance in the
hypothesis explaining the relationship between unex-
pected inflation and stock prices. They are based on
nominal contracting and tax effects, investors’
misperception, and real-activity consequences of
unexpected inflation.
Modigliani and Cohn (1979) attribute the
negative effect of unexpected inflation to the existence
of collective money illusion. Unexpected inflation
raises nominal interest rates and if investors use the
S. A. M. Al-Rjoub
higher rates to discount future earnings, ignoring
the positive effect of inflation on nominal earnings,
the results is an incorrect under-valuation of stocks.
Feldstein (1980) argues that inflation lowers
stock prices because non-neutralities in the tax
treatment of the inventory and depreciation charges
cause inflation to lower real after tax profits.
Fama (1981) argues that the negative inflation-stock
return relationship is generated by a positive casual
link between real output and stock returns coupled
with an inverse correlation between real output
and inflation. Fama (1981) implicitly argues that
unexpected decline in real activity leads to an
accommodating rise in inflation created by aggregate
supply shocks. The argument in Fama (1981) was
extended and further tested in a series of papers:
Kaul (1987), Ely and Robinson (1992), Geske and
Roll (1992), Balduzzi (1995) and Graham (1996).
Kaul (1987) also suggest that, in one way or another,
changes in real activity and the money supply is
behind the negative relationship between inflation
and stock returns. Following the same line Marshall
(1992) argues that the negative inflation-returns
correlation may be generated by real economic
fluctuations, by monetary fluctuations, or possibly
both. Marshall also suggests that this negative
correlation is more strongly negative when inflation
is caused by fluctuations in real economic activity
than when it is caused by monetary fluctuations
(supporting Fama prediction). Chatrath et al. (1997)
test the relationship between stock market returns
and inflationary trends in India; in particular they
test whether the negative stock return-inflation
relationship is explained by a negative relationship
between inflation and real economic activity, and
a positive relationship between real activity and stock
returns. Chatrath et al. provide partial support for
the Fama’s hypothesis, found negative unexpected
inflation coefficient and absence of stock market
returns and inflation in India.
Geske and Roll (1983) suggest the reverse
causality hypothesis between inflation and stock
returns; the evidence is still not conclusive. They
also suggested that if negative real macroeconomic
shocks are accommodated by monetary expansion,
one observes a simultaneous decline in stock prices
and an increase in inflation.
Titman and Warge (1989) offered another
explanation where the stock returns are the predictor
of inflation using lagged stock returns. This relation
is found to be positive. In a recent contribution,
Hess and Lee (1999) account for the stock returns-
inflation relation with a supply and demand shock.
Supply shocks are characterized as shocks to real
The adjustments of stock prices to information about inflation
activity, while the demand shocks originate largely
through shocks to the money supply.
III. Data and Methodology
Data
Emerging Markets Data Base (EMDP) served as the
source for information on stock markets in five
emerging MENA countries: Bahrain, Egypt, Jordan,
Oman and Saudi Arabia. A stock market index is
used to represent the stock markets in each country.
For the Consumer Price Index (CPI) data,
International Financial Statistical (IFS) database is
used. The inflation rates are calculated as the
percentage change in the CPI. All data are monthly.
The sample period is different across these countries
and can be summarized as shown in Table 1.
Before moving to methodology it’s important to
stress the important relationship between market
capitalization and Gross Domestic Product (GDP).
One expects a development of equity markets to lead
to a richer country. Table 2 includes some market
development indicators such as the GDP and GDP
growth; GDP per capita adjusted for purchasing
power parity and Market capitalization as percent-
age of GDP. Data are available from the World
Development Indicators CD. In order to stand on the
relationship between market development (as proxied
by market capitalization) and GDP growth one
regresses per capita GDP on market capitalization
as a percentage of GDP. In three out of five countries
beta coefficients were positive and significant. The
beta coefficient for Bahrain cannot be considered as
valid due to small sample problems. Finally, the beta
for Jordan shows no positive relationship between
per capita GDP and market capitalization, beta
coefficient is insignificant.
Methodology
This study investigates the effect of unexpected
inflation on stock returns in five MENA countries:
Bahrain, Egypt, Jordan, Oman and Saudi Arabia
using a family of GARCH models. The family nests
two basic models: EGARCH in mean and Threshold
GARCH.
Table 1. Sample periods
Bahrain Egypt Jordan
1999:01–2002:07 1996:01–2002:07 1978:12–2002:07
873
Modelling the asymmetric effect
using EGARCH-M and TARCH
Despite the apparent successes of ARCH and
GARCH parameterizations, these models cannot
capture the asymmetric news effect discovered by
Black (1976) and confirmed by Zakoian (1990),
Nelson (1991), Engle and Ng (1993), Glosten et al.
(1993) among others. This asymmetric effect (some-
times called the leverage effect) reflects the observed
fact that downward movements in the market are
followed by higher volatilities than upward move-
ments of the same magnitude. Statistically, the
leverage effect occurs when an unexpected drop in
price (bad news) increases predictable volatility more
than an unexpected increase in price (good news) of
similar magnitude. If unexpected inflation is consid-
ered a bad news for the stock market, then
unexpected inflation should be associated with a
decrease in stock prices at the current time (assuming
a one month lag).
The unexpected inflation-stock return effect is
tested using the univariate EGARCH (p, q)-M model
as shown below:


Rit ¼
i þ im UNEX þ #t2 þ "it , "it
N 0, IT
2
,

2
2  "t1
log it ¼ ! þ   log it1 þ @  pffiffiffiffiffi
it2
2 3
pffiffiffiffiffiffiffiffi7
6 "t1
þ  4qffiffiffiffiffiffiffiffiffiffi  2=5
2
it1
i ¼ Bahrain, Egypt, Jordan, Oman,
and Saudia Arabia ð1Þ
where
Rit is the monthly rate of return on the market
portfolio of assets for country i in period t.
UNEX represents the unexpected inflation esti-
mates as the residuals form the first order
moving average process of the inflation rate.
it2 is the conditional variance at period t.
!, , @,
and  are constant parameters.
In this model if  < 0, then the leverage effect
exists and if  6¼ 0 the impact is asymmetric.
The EGARCH model is asymmetric because
the level of the standardized errors is included with
Oman Saudia Arabia
1999:01–2002:07 1997:12–2002:07
874 S. A. M. Al-Rjoub
Table 2. Market capitalization of stock exchanges and GDP
Data are from World Development Indicators CD. B is the beta coefficient of regressing per capita GDP on market
capitalization as a percentage of GDP. The standard errors are computed using the Newey-West heteroskedasticity and
autocorrelation-consistent estimator of the covariance matrix P-values are in parentheses.

GDP per GDP Market cap

Country GDP GDP growth capita growth per capita, listed companies
code Year (current US ($)) (annual %) (annual %) PPP ($) B (% of GDP)
BHR 26.9 (0.05)
1998 6.18394 4.79 1.0416 13720 109.47711
1999 6.62065 3.9599 3.5323 14750 108.07088
2000 7.97069 5.3699 4.9366 15820 83.104467
2001 7.93505 0 0.411 16060 83.187865
EGY 8.3 (0.00)
1988 35.0446 5.3007 2.8032 2220 5.0221669
1989 39.6484 4.9723 2.5416 2260 4.3154284
1990 43.1304 5.7017 3.3136 2390 4.0922394
1991 36.9705 1.0788 1.136 2380 7.1705715
1992 41.856 4.4334 2.216 2520 7.7862038
1993 47.1968 2.8813 0.7668 2590 8.0810431
1994 51.8979 3.948 1.8824 2660 8.2141921
1995 60.1592 4.6652 2.6567 2810 13.444318
1996 67.6512 5.0096 3.0749 2910 20.950096
1997 75.8702 5.4923 3.4944 2990 27.454781
1998 82.0838 4.5489 2.5731 3030 29.702563
1999 89.0887 6.2848 4.2699 3250 36.859868
2000 99.4275 5.1084 3.127 3470 28.90647
2001 98.4757 2.8999 1.0039 3520 24.542076
JOR 2.6 (0.42)
1988 6.04982 1.852 5.247 3880 36.910175
1989 4.12843 13.45 16.51 3180 52.368502
1990 4.02026 0.9737 2.657 3140 49.772802
1991 4.19333 1.8238 8.947 3040 59.90457
1992 5.36646 18.829 12.844 3470 62.704191
1993 5.6658 4.63 0.002 3500 86.324934
1994 6.29738 4.978 0.9734 3580 72.950929
1995 6.81158 6.3815 2.9793 3770 68.559635
1996 7.02731 2.0997 0.97 3770 64.761576
1997 7.32358 3.0692 0.029 3710 74.362468
1998 7.95901 2.9433 0.151 3630 73.350763
1999 8.13399 3.0949 0.004 3720 71.637643
2000 8.45134 3.9999 0.8728 3820 58.487767
2001 8.8291 4.2 1.2176 3870 71.513484
OMN 7.6 (0.01)
1992 11.3076 6.7683 0.567 10330 9.3830098
1993 11.1674 7.0014 0.3205 10690 9.742565
1994 11.3102 3.511 0.6191 11330 15.07479
1995 12.1019 3.2 0.3481 9840 16.344473
1996 15.2769 2.8999 1.1005 11250 17.424907
1997 15.8387 6.2 2.2928 11490 44.877273
1998 14.0858 2.6499 0.5987 11720 31.180281
1999 15.7113 0.269 2.223 11680 27.381544
2000 19.8257 5.1799 2.4741 12040 17.467185
SAU 31.4 (0.05)
1991 118.034 10.477 7.1021 12250 40.846459
1992 123.204 2.7868 0.449 12810 44.608843
1993 118.515 0.637 3.203 12750 44.528407
1994 120.168 0.4815 2.112 12970 32.193202
1995 127.823 0.4424 2.15 12970 32.002658
1996 157.743 1.3931 1.224 13030 29.073118
1997 164.993 2.003 0.63 12890 35.992971
1998 145.967 1.7376 0.859 12660 29.159138
1999 161.172 0.785 3.305 12520 37.500256
2000 188.72 4.8499 2.1929 13460 35.592761
2001 186.488 1.2 2.039 13330 39.25547
The adjustments of stock prices to information about inflation 875
a coefficient . This coefficient is typically negative Table 3. Selection of a model using Ljung–Box Q-statistics
without violating the non-negative variance
The Ljung–Box
condition. This allows for positive return shocks Q-statistics The Ljung–Box
to generate less volatility than negative return for AR (1) Q-statistics for
innovations, all else being equal.1 ARMA (1,0) ARMA(1, 1)
While the unexpected inflation-stock return effect Bahrain Q(8) LOS* ¼ 0.006 Q(8) LOS ¼ 0.173
is tested using the univariate TARCH ( p, q)-M model Q(12) LOS ¼ 0.036 Q(12) LOS ¼ 0.066
as shown below: Egypt Q(8) LOS ¼ 0.819 Q(8) LOS ¼ 0.816
Q(12) LOS ¼ 0.513 Q(12) LOS ¼ 0.517
R~ it ¼
i þ im UNEX þ #t2 þ "it ,"it
Nð0, IT
2
Þ Jordan Q(8) LOS ¼ 0.14 Q(8) LOS ¼ 0.18
Q(12) LOS ¼ 0.02 Q(12) LOS ¼ 0.034
t2 ¼ ! þ
"2t1 : þ "2t1 dt1 þ t1
2
ð2Þ Oman Q(8) LOS ¼ 0.725 Q(8) LOS ¼ 0.991
Q(12) LOS ¼ 0.114 Q(12) LOS ¼ 0.597
where dt ¼ 1 if "t < 0, and zero otherwise. Saudi Arabia Q(8) LOS ¼ 0.876 Q(8) LOS ¼ 0.892
Q(12) LOS ¼ 0.887 Q(12) LOS ¼ 0.910
In this model, good news ("t < 0) and bad news
("t > 0), have differential effects on the conditional Note: *Level of signifiance.
variance-good news has an impact of
, while bad
news has an impact of
þ . If  > 0 one says that
the leverage effect exists. If  6¼ 0, the news impact is IV. EGARCH and TARCH Results
asymmetric.
The unexpected effects of inflation are investigated
simultaneously by incorporating them into two
Selecting the Wright model to describe alternative models of monthly returns. Table 4
the inflation process in MENA countries presents the results from the EGARCH-M (p, q),
An important question arises when one tries to TARCH-M (p, q) models to test for asymmetric
describe the inflation process in these five MENA effects during the periods of the study. The process
countries; what is the proper model? That is, what is is estimated in this step with the method of maximum
the best-fitting ARMA model? likelihood using Gauss–Newton BHHH and/or
In order to answer this question the Ljung- Marquardt methods.2 The standard errors are
Box Q-statistics is used. If the sample value of Q computed using the White heteroscedasticity consis-
exceeds the critical value of 2 with n degrees of tent estimator of the covariance matrix (White, 1980).
freedom, then at least the value of the tested series is In order to hit the point addressed in this study
statistically different from zero at the specified the constant and the slope in the mean equations of
significance level. In order to test whether the EGARCH and TARCH are reported and the
ARMA(p, q) model fits the inflation data the coefficients of the squared residuals and the leverage
Ljung–Box Q-statistics are reported for the residuals effect in the variance equations. Both the news impact
for lags 8 and 12 in Table 2. and the leverage effect are tested.
Table 3 shows the results of the best-fitting EGARCH results in Table 4 indicate that the
ARMA models for inflation in Bahrain, Egypt, unexpected inflation has a negative impact on stock
Jordan, Oman and Saudi Arabia. Best-fitting market returns in all the MENA countries. The
ARIMA models are determined after constructing impact is high and significant in Bahrain, Egypt,
the ACF and PACF for the residuals of the estimated Jordan and Saudi Arabia, and significant in Oman.
model. The Ljung–Box Q-statistics and the serial The leverage effect () for Bahrain is negative and
correlation Lagrange multiplier (LM) tests accept the statistically different from zero, indicating the
null hypothesis that there is no serial correlation in existence of the leverage effect in stock market
the equations. Inflation rate is modeled using an return during the 1999 : 01 through 2002 : 07 sample
ARMA (1, 1) model and. The residuals from inflation periods. The impact is asymmetric On the other hand
regressions represent unexpected inflation. the leverage effect () for Egypt is positive and

1
For more detailed specification of EGARCH see Nelson (1990), and Engle and Ng (1993).
2
BHHH algorithm follows Newton–Raphson. It replaces the negative of the Hessian by an approximation formed from the
sum of the outer product of the gradient vectors for each observation’s contribution to the objective function. The Marquardt
algorithm modifies the Gauss–Newton algorithm in exactly the same manner as BHHH modifies the Newton–Rapson
method. By adding a ridge factor to the Hessian approximation, this correction handles numerical problems when the outer
product is near singular and may improve the convergence rate.
 876
Table 4. News effect of inflation
This table reports the results of the EGARCH (p, q)-M, and TGARCH (p, q) models. P-values are in parentheses.
and  are the coefficients for the mean equation
in the EARCH-M and the TGARCH while
and  are those for the variance equations to represent the leverage affect.

EGARCH ( p, q)-M TGARCH

Saudia Saudia
Coefficients Bahrain Egypt Jordan Oman Arabia Bahrain Egypt Jordan Oman Arabia

1999:01– 1996:01– 1978:12– 1999:01– 1997:12– 1999:01– 1996:01– 1978:12– 1999:01– 1997:12–
Mean equation 2002:07 2002:07 2002:07 2002:07 2002:07 2002:07 2002:07 2002:07 2002:07 2002:07

29.22 2.12 132.7 93.64 0.014 7.38 5.31 132.25 96.01 1.58
(0.02) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.03)
 60.43 164.85 108.47 278.11 1.62 164.74 1.42 92.28 268.32 292.2
(0.00) (0.00) (0.02) (0.09) (0.00) (0.00) (0.37) (0.05) (0.37) (0.00)
Variance equation

1.65 0.9 0.605 0.955 3.716
(0.00) (0.00) (0.00) (0.00) (0.00)
 1.15 3.11 0.069 0.195 0.246 3.90 59.15 0.059 0.0053 5.312
(0.00) (0.00) (0.09) (0.36) (0.54) (0.00) (0.00) (0.29) (0.98) (0.00)

þ 2.25 58.25 0.546 0.9497 1.596

S. A. M. Al-Rjoub
The adjustments of stock prices to information about inflation
statistically different from zero, indicating the
non-existence of the leverage effect in stock market
return during the 1999 : 01 through 2002 : 07 sample
period. Results are similar for Jordan. For Oman and
Saudi Arabia there is no news effect of inflation on
stock market data.
TARCH results are reported in panel B of
Table 4. Results shows that unexpected inflation
has a negative effect on Bahraini (164.74 with a
P-value of (0.00)), Jordanian (92.28 with P-value
(0.05)), and Saudi stock market return (292.2 with
a P-value of (0.00)). The coefficients of unexpected
inflation are negative and highly significant. Only
Oman and Egypt shows insignificant results where
unexpected inflation shows no effect on stock market
return data in the sample period. When testing for
the leverage effect results shows the following: (1) 
for Bahrain, Egypt and Saudi Arabia are negative
and significant indicating that leverage effect do not
exists for these countries, (2)  is not significantly
positive for Jordan and Oman so there appears to be
no asymmetric effect. The results are similar for those
of EGARCHs.
All these results indicate that the stock markets
of the listed MENA countries do not feel the high up
and down movements in the markets and as such the
volatilities. The asymmetric news effect is absent.
To assess the general descriptive validity of the
model, a battery of standard specification tests is
employed. The test results are presented in Tables 5
and 6. Specification adequacy of the first two
conditional moments is verified through serial
correlation tests of white noise. The Ljung–Box
Q-Test is employed for serial correlation in the
squared-standardized residuals ("2t /ht). All series are
Table 5. Diagnostic statistics of the residuals from EGARCH estimation
This table includes a battery of standard specification tests. The squared standardized residuals ("2t =h) are reported.
J–B probability is the P-value for testing for normality in the EGARCH ( p, q)-M residuals. Standard errors are computed
using the robust inference procedures developed by Bollerslev and Wooldridge (1988).
EGARCH ( p,q)
"2t =ht squared standardized residuals
Skewness Kurtosis J–B probability
Bahrain 15.36 246.13 0.000
EGARCH (1.1)
Egypt 13.79 212.86 0.000
EGARCH (1,3)
Jordan 2.56 15.03 0.00
EGARCH (1,2)
Oman 15.36 246.13 0.000
EGARCH (1,1)
Saudia Arabia 7.624 66.00 0.00
EGARCH (1,3)
877
free of serial correlation at the standard 1% level
of significance. A Jarque–Bera LM test also always
overwhelmingly rejects the null of normality.
Further, a Lagrange Multiplier test is carried out to
examine whether the standardized residuals exhibit
additional ARCH. It is found that in all cases, the
variance equations are correctly specified and that
there should be no ARCH left in the standardized
residuals. The F-test statistics and their p-values
indicate this result. All the F-statistics are insignif-
icant across the two time periods. The coefficients
of skewness and kurtosis show severe evidence
against the conditional normality assumption in the
residuals. The statistics show that returns are
negatively skewed although the skewness statistics
are not large. However, all the kurtosis values are
much larger than 3, significantly different from that
of normal distribution. This indicates that much of
the non-normality is due to leptokurtosis. Despite
these facts, the estimates are still consistent
under quasi-maximum likelihood assumptions. The
GARCH models encompass an autocorrelation
correction and are robust under non-normality.
Overall, results in Table 5 and 6 support the model
specification.
V. Conclusion
This study extends the empirical evidence by analys-
ing the reaction of monthly stock returns to the
unexpected portion of CPI inflation rate and by
capturing the asymmetric shocks to volatility of
unexpected inflation in five MENA countries.
Both Threshold GARCH and Exponential GARCH
ARCH LM test for the GARCH
model specification
Ljung–Box (24) F-stat P-value
A
1.093 0.00037 0.98
18.525A 0.008578 0.77
14.694A 0.08325 0.77
1.093A 0.0124 0.911
23.683A 2.22536 0.1369
878 S. A. M. Al-Rjoub
Table 6. Diagnostic statistics of the residuals from TARCH estimation
This table includes a battery of standard specification tests. The squared standardized residuals ("2t =h) are reported.
J–B probability is the P-value for testing for normality in the TARCH ( p,q)-M residuals. Standard errors are computed using
the robust inference procedures developed by Bollerslev and Wooldridge (1988).

EGARCH ( p,q)

ARCH LM test for the

"2t =ht squared standardized residuals GARCH model specification

Skewness Kurtosis J–B probability Ljung–Box (24) F-stat P-value

A
Bahrain 14.06 216.79 0.00 14.251 0.506 0.477
EGARCH (1.1)
Egypt 16.65 278.7 0.000 0.036 0.0002 0.988
EGARCH(1,2)
Jordan 3.145 19.32 0.00 16.44A 3.0858 0.80
EGARCH(1,2)
Oman 2.17 9.94 0.00 20.284A 0.539 0.465
EGARCH(1,1)
Saudi Arabia 12.015 171.62 0.00 87.39 2.143 0.144
EGARCH (1,3)

are used to catch the news affect that unexpected
inflation may have on stock returns.
After selecting the right model to describe the
inflation process in MENA countries, unexpected
inflation is regressed over the stock market return for
the five MENA countries: Bahrain, Egypt, Jordan,
Oman and Saudi Arabia. Results show a negative and
strongly significant relationship between unexpected
inflation and stock returns in these countries. Results
also indicate that the stock markets of the listed
MENA countries do not feel the high up and down
movements in the markets and as such the volatilities.
The asymmetric news effect is absent.
References
Balduzzi, P. (1995) Stock returns and the ‘proxy
hypothesis’: a new look at the data, Economics
Letters, 48, 47–53.
Black, F. (1976) Studies of stock price volatility changes,
in proceedings of the 1976 meetings of the Business and
Economic Statistis Section, American Statistical
Association, pp. 177–81.
Bodie, Z. (1976) Common stocks as a hedge against
inflation, Journal of Finance, 31, 459–70.
Box, G. and Jenkins, G. (1976) Time Series Analysis:
Forecasting and Control, Holden-Day, New York.
Boudoukh, J. and Richardson, M. (1993) Stock returns
and inflation: a long-horizon perspective, American
Economic Review, 83, 1346–55.
Caporale, T. and Jung, C. (1997) Inflation and real stock
prices, Applied Financial Economics, 7, 265–6.
Chatrath, A., Ramchander, S. and Song, F. (1997) Stock
prices, inflation and output: evidence from India,
Applied Financial Economics, 7, 439–45.
Ely, D. P. and Robinson, K. J. (1992) Stock returns
and inflation: future tests of the role of the
Central Bank, Journal of Macroeconomics, 14,
525–43.
Engle, R. and Ng, V. (1993) Measuring and testing
the impact of news on volatility, Journal of Finance,
48, 1749–78.
Fama, E. F. (1981) Stock returns, real activity,
inflation and money, American Economic Review, 4,
545–65.
Fama, E. and Schwert, W. (1977) Asset return and
inflation, Journal of Financial Economics, 5, 115–46.
Fisher, I. (1930) The Theory of Interest, Macmillan,
New York.
Feldstein, M. (1980) Inflation and the stock market,
American Economic Review, 70, 839–47.
Geske, R. and Roll, R. (1983) The monetary and fiscal
linkage between stock returns and inflation,
Journal of Finance, 38, 1–33.
Glosten, L. R., Jagannathan, R. and Runkle, D. (1993)
On the relation between the expected value and the
volatility of the normal excess return on stocks,
Journal of Finance, 48, 1779–801.
Graham, F. C. (1996) Inflation, real stock returns
and monetary policy, Applied Financial Economics,
6, 29–35.
Hardouvelis, G. (1987) Macroeconomic information
and stock prices, Journal of Economics and
Business, 39, 131–40.
Hess, P. J. and Lee, B.-S. (1999) Stock returns and
inflation with supply and demand disturbances,
Review of Financial Studies, 12, 1203–18.
Jaffe, J. and Mandelker, G. (1976) The ‘Fisher Effect’
for risky assets: an empirical investigation, Journal of
Finance, 31, 447–58.
Kaul, G. (1987) Stock returns and inflation: the role of
the monetary sector, Journal of Financial Economics,
18, 253–76.
Lintner, J. (1975) Inflation and security return, Journal of
Finance, 30, 259–80.
The adjustments of stock prices to information about inflation
McQueen, G. and Roley, V. V. (1993) Stock prices, news,
and business conditions, Review of Financial Studies,
6, 683–707.
Modigliani, F. and Richard, A. C. (1979) Inflation, rational
valuation and the market, Financial Analysts Journal,
35, 24–44.
Nelson, C. R. (1976) Inflation and rates of return
on common stock, Journal of Finance, 31, 471–83.
Nelson, D. B. (1991) Conditional heteroskedasticity in
asset returns: a new approach, Econometrica, 59,
347–70.
879
Pearce, D. K. (1985) Stock prices and economic news,
Journal of Business, 58, 49–67.
Pearce, D. K. and Roley, V. V. (1983) The reaction of
stock prices to unanticipated changes in money: a
note, Journal of Finance, 38, 1323–33.
Schwert, G. W. (1981) The adjustment of stock prices to
inflation, Journal of Finance, 36, 15–29.
Titman, S. and Warga, A. (1989) Asset pricing and
expected inflation, Journal of Finance, 41, 209–23.
Zakoian, J. M. (1990) Threshold Heteroskedastic Models,
Manuscript, CREST, INSEE, Paris.