Equities as long-term inflation hedges: small versus large company stocks

Abstract

The central argument of this article is that small company stocks are better inflation hedges than large company stocks. That is because smaller companies tend to be more flexible to adjust their prices when inflationary shocks exist. Our econometric analysis provides supportive evidence for this hypothesis in the US context.

Keywords:

• small stocks
• inflation
• cointegration
• Fisher hypothesis

JEL Classification:

• G00
• G10

Notes

¹ Practitioners frequently argue for this point in popular press, see Hellmich (2014) for a recent example.

² Kim and In (2005) rely on a different econometric approach, the wavelet analysis, and report similar evidence. See also Ciner (2015) for a frequency domain application of the same hypothesis using a more recent data set.

³ Batten et al. (2014) recently use this approach in prior work to test for cointegration between gold prices and inflation. The Saikkonen and Lutkepohl approach first estimates the deterministic terms in the series by the generalized least squares and then applies a Johansen type test to the adjusted series by means of reduced rank regressions.

⁴ The statistical significance of the factor loadings indicate that the long-term adjustment is done by Wilshire Small-Cap (SCAP) in the system, and hence, the long-term causality runs from CPI to SCAP. Also, it is noteworthy that more robust evidence on stability of the factor loadings could be obtained from formal tests of structural breaks such as those developed by Bai and Perron (2003). However, to maintain brevity of this article, we leave that for future research. We thank an anonymous referee for suggesting this point.