High Inflation: Low Default Risk and Low Equity Valuations

Harjoat S, Christian Dorion, Alexandre Jeanneret, Michael Weber and Stijn Van

The Review of Financial Studies, 2023, vol. 36, issue 3, 1192-1252

Abstract: We develop an asset pricing model with endogenous corporate policies that explains how inflation jointly affects real asset prices and corporate default risk. Our model includes two empirically founded nominal rigidities: fixed nominal debt coupons (sticky leverage) and sticky cash flows. These two frictions result in lower real equity prices and credit spreads when expected inflation rises. A decrease in expected inflation has opposite effects, with even larger magnitudes. In the cross-section, the model predicts that the negative impact of higher expected inflation on real equity values is stronger for low leverage firms. We find empirical support for the model’s predictions.Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

JEL-codes: E44 G12 G32 G33 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (4)

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