Hence the models should show a significant negative relationship between stock prices and inflation. Empirical literature on the relationship between inflation and stock price includes a study by Geyser and Lowies, "The Impact of Inflation on Stock prices in Two SADC Countries-. The results of this study actually showed a strong positive correlation between stock price changes and inflation for all the selected companies in Namibia. On the other hand, companies in the mining sector in South Africa showed a negative correlation and hence were thought to be a good hedge against inflation.
TBR: There is generally a negative relationship between stock prices and the interest rate which is due to the present value concept and substitution effects. The higher the interest rate, the lower the present value of the returns on shares. As the return is determined by the price paid for the share, investors will only pay a relatively lower price as interest rates rise in order to maximise returns and hence utility. Other theory suggests that as interest rtes increase, a higher return can be gained ion a bank deposit. Hence investors will want to pay a lower price for shares. An example of this is that If the interest rate paid to depositors is 5%, a block of shares expected to pay £5000 a year is as good as £100,000 in the bank, and investors will be willing to pay around that amount for the shares. But if the interest rate rises to 10%, the same block of shares is equivalent only to £50,000 in the bank. So interest rates and share markets tend to move in opposite directions . Hence a significant negative relationship can be expected between stock prices and inflation.
IP: Theory suggests a positive relationship between industrial production and money supply. Industrial production represents real economic activity in this case. It can be interpreted that as economic activity rises, firms become more profitable and this is then reflected in higher stock prices.
