Equities as a hedge against inflation in South Africa

Abstract

Conventional wisdom holds that equity investments should provide an effective hedge against inflation. However, empirical tests of this relationship in South Africa have produced conflicting results. We employ both a Vector Error Correction Model (VECM) and Autoregressive Distributed Lag Model (ARDL) to examine the relationship between equity returns and inflation for the Johannesburg Stock Exchange between 1980 and 2015. We find strong evidence of cointegration between equity returns and inflation with a positive coefficient that exceeds unity supporting equities’ ability to act as a hedge against inflation. The VECM, however, shows that within the cointegrating relationship it is primarily inflation that responds to changes in equity returns and that this process takes place over an extended length. Thus holding equities as a hedge against inflation is only likely to be effective over longer investment horizons.

Keywords: Inflation; Fisher Effect; Fama’s Proxy Hypothesis; ARDL; Johannesburg Stock Exchange.