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Low Inflation: High Default Risk AND High Equity Valuations

Harjoat Bhamra, Christian Dorion, Alexandre Jeanneret and Michael Weber ()

No 7391, CESifo Working Paper Series from CESifo Group Munich

Abstract: We develop an asset-pricing model with endogenous corporate policies that explains how inflation jointly impacts real asset prices and corporate default risk. Our model includes two empirically grounded nominal frictions: fixed nominal coupons and sticky profitability. Taken together, these two frictions result in higher real equity prices and credit spreads when inflation falls. An increase in inflation has opposite effects, but with smaller magnitudes. In the cross section, the model predicts the negative impact of inflation on real equity values is stronger for low leverage firms. We find empirical support for the model predictions.

Keywords: low inflation; default risk; equity; leverage; credit spreads (search for similar items in EconPapers)
JEL-codes: E44 G12 G32 G33 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac and nep-rmg
Date: 2018
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