Table 7-6 (found on the textbook's Web site) gives data on the real rate of return (Y) on common stocks, the output growth (X2), and inflation (X3), all in percent for the United States for 1954 to 1981.
a. Regress Y on X3.
b. Regress Y on X2 and X3.
c. Comment on the two regression results in view of Professor Eugene Fama's observation that "the negative simple correlation between real stock returns and inflation is spurious (or false) because it is the result of two structural relationships: a positive relation between current real stock returns and expected output growth and a negative relationship between expected output growth and current inflation."
d. Do the regression in part (b) for the period 1956 to 1976, omitting the data for 1954 and 1955 due to unusual stock return behavior in those years, and compare this regression with the one obtained in part (b). Comment on the difference, if any, between the two.
e. Suppose you want to run the regression for the period 1956 to 1981 but want to distinguish between the periods 1956 to 1976 and 1977 to 1981. How would you run this regression?