Time-Varying Inflation Risk and the Cross-Section of Stock Returns

77 Pages Posted: 8 Nov 2014

See all articles by Dominic Burkhardt

Dominic Burkhardt

University of Zurich/Swiss Finance Institute

Date Written: October 22, 2014

Abstract

I provide empirical evidence indicating that inflation risk is time-varying and priced in the cross-section of individual stocks in the U.S. and UK equity markets. I establish that the way inflation risk is priced in equity markets is closely related to the cyclicality of inflation. I show that the market price of inflation shocks is positive (negative) in the cross-section of individual stocks when inflation is procyclical (countercyclical) and hence comoves positively (negatively) with measures of economic activity. As a consequence, risk premiums on stocks with positive/negative exposure to inflation shocks depend on whether the economy is in a pro- or countercyclical inflation regime. A zero-investment strategy that goes long low (high) inflation-beta stocks and short high (low) inflation-beta stocks when inflation is countercyclical (procyclical) yields economically large and statistically significant return premiums in both markets, even after controlling for well-known risk-factors.

Keywords: inflation risk, cyclicality of inflation, cross-section of stock returns

JEL Classification: E31, E44, G12, G15

Suggested Citation

Burkhardt, Dominic, Time-Varying Inflation Risk and the Cross-Section of Stock Returns (October 22, 2014). Available at SSRN: https://ssrn.com/abstract=2520083 or http://dx.doi.org/10.2139/ssrn.2520083

Dominic Burkhardt (Contact Author)

University of Zurich/Swiss Finance Institute ( email )

Rämistrasse 71
ZĂ¼rich, CH-8006
Switzerland

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