An Empirical Analysis Of The Fisherian Hypothesis On The Malaysian Equity Market

Abstract

The negative effect of inflation on risk free debt contracts offering nominal payoffs in future time | period is commonly acknowledged by financial researchers. The relationship known as the Fisher | effect claims that nominal interest rates proportionately adjust to changes in the expected price level. | Higher expected price level reduces the real value of future promised nominal cash flows, thus, reducing | the valu of deb. Extension of Fisherian. hypothesis on isky asses such a5 common stock mostly | reject its validity. Contrary to economic theory, existing evidence indicates that common stock fails 10 perform as an effective hedge against inflation despite being a claim on real assets. This study | investigates the validity of Fisherian hypothesis in the Malaysian equity market. In contrast to the previous study. we examine the Fisher effect based on the stochastic process of common stock and | price indices. It is shown that both, common stock and price indices, are nonstationary rendering traditional least square analysis using level series invalid. However, our analysis indicates that both | series are cointegrted,.. they obeying a long-run equilibrium path consistent with the Fisher effect. | Over the long run, stock and price indices move together. Further, th results also support stationarity of ex-ante real common stock returns. Mean reversion of ex-ante eal rtums strengthens the case for Fisher effect in the Malaysian equity market. Thus, for the case of Malaysia common stock is | an effective hedge against erosion of purchasing power due to increase in the price level. |