Stocks, inflation, and market power. Investigating stocks' inflation hedging ability in the European market.

Abstract

This empirical research investigates the ability of stocks to hedge against inflation in European markets. In line with that, this work aims to identify whether companies' market power affects stock excess returns. Also, this research answers whether portfolios with different inflation hedging abilities perform differently and if investors would be willing to pay a premium on diversified portfolios with raised inflation exposure. These research questions are approached to be answered by conducting a time series regression analysis regarding stocks’ exposure to macroeconomic and microeconomic factors. The empirical findings suggest that, while stocks, on average, do not have a hedging ability against changes in inflation, selected stocks do. Also, regarding inflation exposure, market power does not affect stock excess returns. Additionally, portfolios with low inflation hedging abilities perform better than good inflation hedged portfolios. Lastly, creating an additional inflation risk factor in the asset pricing environment suggests that investors would be willing to pay a higher price for portfolios with a raised inflation exposure.