The Nonlinear Effect of Inflation on the Stock Market: A Threshold Regression Approach

Abstract

In this paper, the authors examine the nonlinear effect of inflation on the stock market among the emerging market and developing economies (EMDEs) in Asia. The stock market is measured by its capitalization to GDP. The data are collected in the Asian EMDEs including China, Indonesia, India, Sri Lanka, Malaysia, Thailand, the Philippines, and Vietnam from the period 2008-2020. By combining the threshold effects and generalized method of moments (GMM), the authors acknowledge the nonlinear effect of inflation on the stock market with the threshold level of 1.9%. Specifically, below 1.9%, inflation is positively correlated to the stock market. This effect, however, turns out to be negative when inflation is above 1.9%. Besides, the authors also reveal the positive influence of economic growth and trade openness on the stock market. This enhances the important role of inflation control and macroeconomic improvements in boosting the stock market. These findings are essential for the Asian EMDEs.