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

54 Pages Posted: 26 Feb 2009 Last revised: 27 Apr 2016

See all articles by Yaniv Konchitchki

Yaniv Konchitchki

University of California, Berkeley - Haas School of Business

Date Written: March 15, 2011

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

JEL Classification: D82, E22, E31, E44, G11, G12, G14, M41, M44

Suggested Citation

Konchitchki, Yaniv, Inflation and Nominal Financial Reporting: Implications for Performance and Stock Prices (March 15, 2011). The Accounting Review, Year 2011, Volume 86, Number 3 (May), Pages 1045-1085. Available at SSRN: https://ssrn.com/abstract=1349929

Yaniv Konchitchki (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

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