Time-Varying Inflation Risk and Stock Returns
104 Pages Posted: 4 Jun 2013 Last revised: 29 Aug 2019
Date Written: November 1, 2018
We show that inflation risk is priced in stock returns and that inflation risk premia in the cross-section and the aggregate market vary over time, even changing sign as in the early 2000s. This time variation is due to both price and quantities of inflation risk changing over time. Using a consumption-based asset pricing model, we argue that inflation risk is priced because inflation predicts real consumption growth. The historical changes in this predictability and in stocks' inflation betas can account for the size, variability, predictability and sign reversals in inflation risk premia.
Keywords: inflation, time-varying inflation risk premium, inflation hedging, individual stock returns, cross-sectional asset pricing, nominal-real covariance
JEL Classification: G11, G12, G13
Suggested Citation: Suggested Citation