The Impact of Inflation on Stock Market Returns and Conditional Volatility: Empirical Evidence from the Saudi Stock Market

Abstract

This paper investigates the impact of inflation on stock market returns and volatility using monthly observations of inflation rate and general stock market index (Tadawul) for the Kingdom of Saudi Arabia over the period from January 1990 to December 2011. The empirical analysis of the paper is carried out by means of the Generalized Autoregressive Conditional Heteroscedastic (GARCH) methodology including both symmetric and asymmetric models. Based on AR-GARCH (1,1) and AR(1)-EGARCH(1,1), the results show that there is no significant effect of inflation rate on the conditional mean equation representing the monthly stock market returns. But, when including the inflation rate into the conditional variance only and on both mean and variance equations, the results indicate a significant positive effect.