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Inflation and Individual Investors' Behavior: Evidence from the German Hyperinflation

Journal: Review of Financial Studies

Date: 20231201

Author: Braggion, Fabio; von Meyerinck, Felix; Schaub, Nic

Abstract:
We analyze how individual investors respond to inflation. We introduce a unique data set containing information on local inflation and security portfolios of more than 2,000 clients of a German bank between 1920 and 1924, covering the German hyperinflation. We find that individual investors buy fewer (sell more) stocks when facing higher local inflation. This effect is more pronounced for less sophisticated investors. Moreover, we document a positive relation between local inflation and forgone returns following stock sales. Our findings are consistent with individual investors suffering from money illusion. Alternative explanations, such as consumption needs, are unlikely to drive our results.

Link: Google Scholar

Key Findings

Individual Investors Sell During High Inflation

Investors buy fewer and sell more stocks when facing higher local inflation, with a 1% increase in local inflation associated with a 3.5% decline in buy-sell imbalances for stocks

Effect Stronger for Less Sophisticated Investors

The negative relationship between inflation and stock purchases is more pronounced for less sophisticated investors and weaker for bank employees, wealthy clients, and institutional investors

Investment Shift During Inflation

During periods of high inflation, investors tend to shift from stocks to bonds, with evidence showing positive buy-sell imbalances for bonds during inflationary periods

Impact of Local Inflation on Stock Trading

  • Buy-sell imbalance decreases significantly as local inflation increases
  • Moving from lowest to highest inflation decile reduces buy-sell imbalances by 17 percentage points
  • Effect persists across different time periods and specifications

Effect Across Investor Types

  • Bank employees and wealthy clients show reduced sensitivity to inflation
  • Effect is 10% weaker for sophisticated investors
  • Institutional investors show positive or neutral response to inflation

Asset Class Preferences During Inflation

  • Positive relationship between inflation and bond purchases
  • Negative relationship with stock purchases
  • No significant relationship with foreign securities

Contribution and Implications

  • First direct empirical evidence that individual investors' behavior is consistent with money illusion
  • Important implications for current debate on financial literacy as inflation resurfaces globally
  • Demonstrates need for better investor education about inflation's effects on investment decisions

Data Sources

  • Buy-sell imbalance chart based on Figure 1 in the article showing relationship between local inflation deciles and trading behavior
  • Investor type effects derived from Table 5 showing differential responses to inflation across investor categories
  • Asset class preferences chart constructed using data from Tables 3, 9, and 10 showing buy-sell imbalances across different security types