Reexamining stock valuation and inflation: the implications of analysts' earnings forecasts

Steven Sharpe

No 2001-32, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: This paper examines the effect of inflation on stock valuations and expected long-run returns. Ex ante estimates of expected long-run returns are constructed by incorporating analysts' earnings forecasts into a variant of the Campbell-Shiller dividend-price ratio model. The negative relation between equity valuations and expected inflation is found to be the result of two effects: a rise in expected inflation coincides with both (i) lower expected real earnings growth and (ii) higher required real returns. The earnings channel mostly reflects a negative relation between expected long-term earnings growth and expected inflation. The effect of expected inflation on required (long-run) real stock returns is also substantial. A one percentage point increase in expected inflation is estimated to raise required real stock returns about one percentage point, which on average would imply a 20 percent decline in stock prices. But the inflation factor in expected real stock returns is also in long-term Treasury yields; consequently, expected inflation has little effect on the long-run equity premium.

Keywords: Inflation (Finance); Stocks (search for similar items in EconPapers)
Date: 2001
New Economics Papers: this item is included in nep-fmk
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Citations: View citations in EconPapers (8)

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Related works:
Journal Article: Reexamining Stock Valuation and Inflation: The Implications Of Analysts' Earnings Forecasts (2002)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2001-32

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