Accounting for Threshold Effects and Asymmetric Adjustment Between Inflation and Equity Returns in South Africa

Abstract

Recent South African empirical tests of the ability of equity to act as a hedge against inflation have generally relied on conventional cointegration tests that assume symmetric adjustment between the variables in the cointegrating relationship, however modern international evidence increasingly indicates that the relationship may not be this straightforward. Using CPI and JSE-ALSI data for the period 1980 - 2015, this study employs a threshold cointegration approach to investigate the long-run relationship between inflation and equity returns allowing for non-linear adjustment. The study finds compelling evidence that the relationship has experienced asymmetric adjustment over the sample period and that the relationship between equity returns and inflation is more appropriately modelled using threshold cointegration. The study confirms the ability of equity returns to protect investors against inflation, even when allowing for asymmetric adjustment, making the results a more robust indicator of the equity returns-inflation relationship.