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High Inflation: Low Default Risk and Low Equity Valuations

Author

Listed:
  • Harjoat S
  • Christian Dorion
  • Alexandre Jeanneret
  • Michael Weber
  • Stijn Van

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.

Suggested Citation

  • Harjoat S & Christian Dorion & Alexandre Jeanneret & Michael Weber & Stijn Van, 2023. "High Inflation: Low Default Risk and Low Equity Valuations," The Review of Financial Studies, Society for Financial Studies, vol. 36(3), pages 1192-1252.
    • Handle: RePEc:oup:rfinst:v:36:y:2023:i:3:p:1192-1252.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhac021
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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