THE RELATIONSHIP BETWEEN STOCK RETURNS AND INFLATION RATES IN NIGERIA FROM 1995 to 2014

Abstract

This study focused on determining the relationship between inflation rate and stock returns using the Consumer Price Index and the All Share Index on the Nigerian Stock Exchange covering the period 1995 to 2014. The data were analyzed for evidence of co-integration and causality using Error Correction and Granger co-integration model. The Pearson Correlation result shows that, there is significant negative relationship between stock returns and inflation rates in Nigeria. Augmented Dickey Fuller result shows that the series are non-stationary in their level form and are integrated of order one. Johansen co-integration test result shows evidence of co-integration implying that there is a long run relationship between stock market returns and inflation rates in Nigeria. Furthermore, there is significant negative impact of inflation rates on stock market returns in Nigeria. The pair-wise Granger causality test shows that there is a strong unidirectional causality. Also, result from the Error Correction Model suggests that about 43% of the variations in stock returns are accounted for by inflation rates. The study recommends economic reforms that target macroeconomic stability in the country, removal of structural twist, and creation of business-friendly environment that ensures price stability as these will encourage investment in stocks in Nigeria.