NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Low Inflation: High Default Risk AND High Equity Valuations

Harjoat S. Bhamra, Christian Dorion, Alexandre Jeanneret, Michael Weber

NBER Working Paper No. 25317
Issued in November 2018
NBER Program(s):Asset Pricing, Corporate Finance, Economic Fluctuations and Growth, Monetary Economics

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.

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Document Object Identifier (DOI): 10.3386/w25317

 
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