Would you like to inspect the original subtitles? These are the user uploaded subtitles that are being translated: The Fisher hypothesis is one of the most debated topics in financial economics literature. According to Fisher (1930), the nominal interest rate in any period is equal to the sum of the real interest rate and the expected rate of inflation. The existence of the Fisher Effect has a lot of implications in other kinds of researches related with the flow-through capability, that is, has implications on the sensitivity of the stock prices when nominal interest rates change due to variations in the expected inflation rate (Jareño, 2005, and Jareño and Navarro, 2010). Thus, the main purpose of this research consists in revising previous literature about Fisher Effect, in order to check if the majority of nominal interest rates movements are caused by inflation rate fluctuations, remaining constant the real interest rate. Second, we analyse the Fisher Effect in the Spanish case with a preliminary analysis, using a very easy proposal. Our final aim lies in validating another kind of researches related with the flow-through capability (Jareño, 2005; Jareño and Navarro, 2010; and Díaz and Jareño, 2012), that is, the ability of the firm to pass on an inflation shock to the firm‟s output prices. Finally, this paper points out the main implications of the Fisher Effect, and our concluding remarks. The percentage in which the nominal interest rates contain inflation expectations keeping constant the real interest rate is named the Fisher Effect. Thus, when expected inflation rate rises in a percentage point (πte), the nominal interest rate (it) also increases in the same percentage and the real interest rate (rte) keeps constant. The Fisher Effect – according to the most of literature- will take place only partly and in the longterm, so that we cannot suppose that a shock in the inflationist expectations – happened at a certain moment - moves to the nominal interest rates of the economy at that same moment and totally. By supposing that this Fisher Effect takes place in the long-term, although partly, this result is very important, and has a lot of implications in other kind of researches related with the flow-through capability. Thus, our result has implications on the sensitivity of the stock prices when nominal interest rates change due to variations in the expected inflation rate. The future research will focus on analysing the repercussion of the Fisher Effect on the company ability to pass inflationist shocks on to product prices. The Fisher equation has some interesting implications: If πte = 0, then it = rte. In this case money is not loosing or gaining any value. Thus, the cost of holding money is equal to its opportunity cost, the real return on assets. Under this condition rte cannot be negative, as it ≥ 0. If πte > 0, then it > rte. For a positive inflation rate, nominal interest rates will always exceed real interest rates. If πte < 0, then it < rte. For a negative inflation rate (= an expected deflation), real interest rates will always exceed nominal interest rates. For a given i, the higher πte, the lower r: ∂rte/∂πte = -1 This case is particularly relevant if an economy is in a liquidity trap where it cannot be influenced by the central bank anymore. Now, after understanding Fisher equation, we finally get to the Fisher Effect: Δit = Δπte. It proposes a 1 : 1 relationship between it and πte. That is, an increase in expected inflation leads to a proportional increase in the nominal interest rate. A problem that arises when testing for the Fisher Effect is the lack of any direct measure of inflation expectations. So we include this debate in this section of the paper. This research uses the most popular approximation to estimate the expected inflation rate: ARIMA models.3 Thus, ARIMA (1, 0, 0) process provides the best results, and we use this process (shortsightedness expectations, according to Leiser and Drori, 2005) to predict the month-to-month inflation rate: An important point in this analysis is concerned to the choice of the adequate interest rate to employ. Most of the literature uses long-term interest rates because they incorporate the future expectations of economic agents and they determine the corporate borrowing cost, so they have a lot of influence on the investment decisions of firms and, consequently, they affect the value of companies. Besides, we have used the total variations in long-term interest rates to capture unanticipated changes in interest rates (Sweeney and Warga, 1986, Kane and Unal, 1988, Bartram, 2002 and Oertmann et al., 2000). Some researchers use alternative procedures such as forecast error of the ARIMA process to model the unexpected interest rate (Flannery and James, 1984). Mishkin (1982) approach the unanticipated changes in interest rates with the spread between spot interest rate of the three month treasury bills in period t and forward rate of the three month treasury bills in yield curve during period t -1. On the other hand, Fendel (2005) develop a Taylor rule expression for the interest rate dynamics and he concludes that interest rates can be sufficiently explained by expected variations in inflation and output plus an additional unobservable factor. An interesting alternative for the use of ARIMA model forecasts are survey forecasts of interest rates they are intrinsically “forward looking”. They have been studied and applied in the literature, comparing with time series approach, getting the conclusion that each approach has their own advantages and drawbacks (Froot, 1989 and Benink and Wolff, 2000). In this study we use first differences of the long-term interest rates as a good approach of the unexpected changes in the nominal interest rates. The body of literature, mainly in the US market, has relied on 1, 3, 5 and 10-year Treasury bond yields and three-month Treasury bill yields as interest rate proxy variable. The returns of the Treasury securities in different maturities are usually used as the risk-free interest rate proxies. It is supposed that these securities have not default risk. In the Spanish case, we have decided to use returns series of the one-year Treasury debt securities. This risk-free interest rate approximation allow us to obtain changes in real interest rates, Δrt, as the difference between variations in nominal interest rates, Δit, and year-to year inflation rate, Δ Et(πt,t+12) In this paper we propose a very direct and easy way to check the Fisher Effect in the Spanish case. This analysis is very important, because the existence of the Fisher Effect has a lot of implications in other kind of researches related with the flow-through capability. One way to show if the expected inflation rate (current and delayed) influences nominal interest rates in the medium term, that is, to analyze the existence of the Fisher Effect in this term consists in carrying out the following test: According to results showed in table 3, a positive and significant relationship exists between variations in the current expected inflation rate and variations in nominal interest rates. Namely, an increment of 100% in the inflation rate gets a nominal interest rates increment around 20%, relying on the past inflation rate too. Thus, we can affirm the existence of partial Fisher Effect in the Spanish case, using a very easy and direct way to check this Spanish Fisher Effect. Also, we avoid using other sophisticated and complex econometric techniques, such as causality and co-integration techniques (Grullón, 2012, and Hossain and Saeki, 2012). Residuals from the regression accord with variations in real interest rates (see figure 2), confirming this existence of partial Fisher Effect. The Spanish economy has experienced annual growth of about 3.7 % for the period 1993-2005, which is well above the European Union average (2.35 %). Although it has been claimed that this growth has been based on the building sector, the increasing role of Spanish companies in the global market, and particularly in the service sectors, is noteworthy. However, one of the main drawbacks of the Spanish economy during this period has been a persistent spread of the domestic inflation rate with respect to other EMU countries, together with very low growth of labour productivity6 compared with other competitors. Although Spain entered the Eurozone in 1999, this difference between Spanish inflation and the European average has not disappeared. This is an interesting topic in that members of a common monetary area should also converge in terms of inflation rates due to the loss of competitiveness that, in the medium and long term, would be caused by such a situation. One potential explanation of these phenomena could be a lack of liberalization or competition in some sectors of the Spanish economy, in the sense that firms in those industries are able to easily transmit inflation shocks to their output prices. According to some of the hypotheses described below, these facts could also have consequences on the impact of changes of nominal interest rates on company stock prices. In short, these hypotheses suggest that when changes in interest rates are due to changes in the expected inflation and simultaneously firms are capable of passing on these inflation shocks to their output prices (and thus to nominal revenues and profits), the impact of these interest rate changes on stock prices should be minimal. A large body of literature (Estep and Hanson, 1980; Leibowitz and Kogelman, 1990 y 1993; Asikoglu and Ercan, 1992) document this phenomenon for different industries and periods. Moreover, Asikoglu and Ercan (1992) show a negative relationship between inflation and stock returns and estimate the flow-through coefficients at an industrial level, showing that companies that operate in sectors with high flow-through capability are less sensitive than those firms that operate in low flow-through capability sectors. Following Jareño and Navarro (2010), changes in nominal interest rates may have a different impact on stock prices depending on whether the change is induced by a shift in inflation expectations or caused by changes in real interest rates. A very controversial point in the literature concerns the stability of real interest rate, i.e., whether or not the so-called Fisher Effect holds. According to Leibowitz and Kogelman (1990), the impact on stock prices of changes in nominal interest rates due to variations in the expected inflation depends, to a large extent, on the capability of firms to absorb these inflation shocks. This argument led to the definition of the flow-through coefficient (Estep and Hanson, 1980, and Asikoglu and Ercan, 1992) as the expected inflation percentage which flows into a firm‟s expected nominal cash-flows and so into firm profits and dividend growth. That is, assuming that the risk premium does not change with changing inflation, if a firm is capable of transmitting a general increase in prices entirely to the prices of its own outputs and thus to its nominal expected profits, this would leave the stock price unchanged. On the contrary, a low flow-through capability (as assumed in the traditional DDM)7 would lead to an extremely high sensitivity of stock prices to interest rate changes. Of course this capability of transferring inflation shocks to nominal profits may depend on the industry this company operates in. A company running a business in an industry exposed to foreign competition (in this case the ability of firms to absorb inflation shocks would be close to zero) would not be the same as another one with significant market power, due to a lack of liberalization or to the presence of dominant firms in some sectors of the economy. In this case, the response of stock prices to a change in nominal interest rates caused by a variation in inflation expectations will be minimal while this effect will increase for firms operating in a competitive environment. CONCLUDING REMARKS This paper analyses previous literature about Fisher Effect, in order to check if the majority of nominal interest rates movements are caused by inflation rate fluctuations, remaining constant the real interest rate. According to the most of literature the Fisher Effect will take place only partly and in the long-term, so that we cannot suppose that a shock in the inflationist expectations – happened at a certain moment - moves to the nominal interest rates of the economy at that same moment and totally. Besides we check if the Fisher Effect in the Spanish case holds with a preliminary analysis in order to validate future studies. In this study we find a positive and significant relationship between variations in the expected inflation rate and changes in nominal interest rate in the period 1993- 2004. In this case, an increment of 100% in the inflation rate gets a nominal interest rates increment around 20%, so we can confirm the existence of partial Fisher Effect. Additionally, we validate another kind of researches related with the flow-through capability that is, the ability of the firm to pass on an inflation shock to the firm‟s output prices. Following Jareño and Navarro (2010), changes in nominal interest rates may have a different impact on stock prices depending on whether the change is induced by a shift in inflation expectations or caused by changes in real interest rates. Thus, if the Fisher Effect exist, a firm capable of transmitting a general increase in prices entirely to the prices of its own outputs and thus to its nominal expected profits, this would leave the stock price unchanged. On the contrary, a low flow-through capability, would lead to an extremely high sensitivity of stock prices to interest rate changes. Of course this capability of transferring inflation shocks to nominal profits may depend on the industry this company operates in. A company running a business in an industry exposed to foreign competition (in this case the ability of firms to absorb inflation shocks would be close to zero) would not be the same as another one with significant market power, due to a lack of liberalization or to the presence of dominant firms in some sectors of the economy. In this case, the response of stock prices to a change in nominal interest rates caused by a variation in inflation expectations will be minimal while this effect will increase for firms operating in a competitive environment.14607