Inflation and Nominal Financial Reporting: Implications for Performance and Stock Prices

Yaniv Konchitchki

MPRA Paper from University Library of Munich, Germany

Abstract: The monetary unit assumption of financial accounting assumes a stable currency (i.e., constant purchasing power over time). Yet, even during periods of low inflation or deflation, nominal financial statements violate this assumption. I posit that, while the effects of inflation are not recognized in nominal statements, such effects may have economic consequences. I find that unrecognized inflation gains and losses help predict future cash flows as these gains and losses turn into cash flows over time. I also find significant abnormal returns to inflation-based trading strategies, suggesting that stock prices do not fully reflect the implications of the inflation effects for future cash flows. Additional analysis reveals that stock prices act as if investors do not fully distinguish monetary and nonmonetary assets, which is fundamental to determining the effects of inflation. Overall, this study is the first to show that, although inflation effects are not recognized in nominal financial statements, they have significant economic consequences, even during a period in which inflation is relatively low.

Keywords: inflation; asset pricing; information; financial reporting; abnormal returns; cash flows; capital markets (search for similar items in EconPapers)
JEL-codes: D82 E22 E27 E31 E44 G11 G12 G14 G17 M1 M4 M41 (search for similar items in EconPapers)
Date: 2011-05
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Citations: View citations in EconPapers (28)

Published in The Accounting Review 3.86(2011): pp. 1045-1085

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:52928

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