The Swedish inflation rate and stock market returns: does the Fisher effect exist?

Abstract: In Sweden the annual inflation rate raised in September 2021 above the Sveriges Riksbank inflation target of two percent annually, which has been the central bank's inflation target since 1995. This created a discussion regarding if the repo interest rate should be increased from currently zero percent. The repo interest rate affects the general interest rate level in the country and when interest rate decreases investors tend to re-allocate their capital towards more riskier assets such as stocks. Previous research has shown that there is a negative correlation in the short-term but possibly a positive correlation in the long-term between stock market return and inflation rate. Thus providing some explanation of stocks acting as a hedge against inflation in the long-term. Furthermore, earlier research has argued that the presence of the Fisher effect depends on country and economic context. By using monthly Swedish stock market return and inflation rate measured by Swedish CPI, this thesis examines if there is any significant evidence for the so-called Fisher effect within the context of the Swedish stock market. Using lagged and lead inflation rates as independent variables, four regressions are tested. The results suggest only a negative relationship between stock market return and inflation rate lagged three months at the 10% significant level. The coefficients for the other lagged and lead inflation rates are found insignificant. In conclusion, the findings present no evidence that the Fisher effect exists at 5% significance level in the Swedish stock market.