Review of Financial Studies Vol. 36 No. 3 2023

High Inflation: Low Default Risk and Low Equity Valuations

Harjoat S. Bhamra¹; Christian Dorion²; Alexandre Jeanneret³; Michael Weber⁴

¹ Imperial College Business School, CEPR , NIESR, and CFM, UK · ² HEC Montreal and CDI Research Fellow , Canada · ³ UNSW Business School , Australia · ⁴ Booth School of Business, University of Chicago , CEPR, and NBER, USA

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.

DOI

10.1093/rfs/hhac021

Volume

36

Issue

3

Pages

1192-1252

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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