The Effect of Inflation Stabilization Plans on Emerging Market Stock Returns

Emerging market stock returns exhibit a strong positive response to inflation stabilization programs. There are three principal components to this finding, which I document for a cross section of 24 emerging economies. First, the magnitude of the response depends upon the type of stabilization initiative. Over a three month stabilization window, cumulative abnormal returns average 23.1 percent for domestic inflation stabilization programs that have no international stamp of approval, versus 4.1 percent for stabilization programs that are sponsored by the International Monetary Fund (IMF); IMF Stand BY arrangements have a larger impact than Extended Fund Facility arrangements. Second, the average level of inflation over the twelve month period preceding implementation helps predict the size of the markets' response to an IMF stabilization program. When inflation exceeds 100 percent, cumulative abnormal returns average 20.4 percent for the three month stabilization period and are statistically indistinguishable from the 23.1 percent effect associated with domestic stabilization programs. When inflation is less than 100 percent, IMF programs do not elicit a significant equity market response. Finally, the stock market does not seem to be able to predict which stabilization programs will be successful; the ex-ante positive abnormal response to stabilizations which are successful ex-post is the same as it is for failed stabilizations. Overall, the results imply that inflation stabilization programs only have a significant effect on the stock market when inflation is very high, and when inflation is very high, it does not matter whether the stabilization plan is IMF sponsored or not