Regime switching in the dynamic relationship between stock returns and inflation

This study examines nonlinear dynamic relationships between stock returns and inflation in ten major stock markets. Using Hansen and Seo's (2002) threshold error correction model to allow for possible regime shifts in the dynamic relationship between the two variables, threshold effects are found in the adjustment towards the long-run equilibrium relationship between stock returns and inflation for three out of the ten countries considered in this study (France, Switzerland and the USA). Nevertheless, the nonlinear adjustment mechanism is not uniform but rather it is country-specific.