High Inflation: Low Default Risk and Low Equity Valuations

130 Pages Posted: 11 Dec 2018 Last revised: 8 Sep 2021

See all articles by Harjoat Singh Bhamra

Harjoat Singh Bhamra

Imperial College Business School

Christian Dorion

HEC Montreal; Canadian Derivatives Institute

Alexandre Jeanneret

UNSW Business School

Michael Weber

University of Chicago - Finance; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: July 22, 2021

Abstract

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
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.

Keywords: high inflation, default risk, equity, leverage, credit spreads

JEL Classification: E44, G12, G32, G33

Suggested Citation

Bhamra, Harjoat Singh and Dorion, Christian and Jeanneret, Alexandre and Weber, Michael, High Inflation: Low Default Risk and Low Equity Valuations (July 22, 2021). Chicago Booth Research Paper No. 18-12, Available at SSRN: https://ssrn.com/abstract=3290745 or http://dx.doi.org/10.2139/ssrn.3290745

Harjoat Singh Bhamra

Imperial College Business School ( email )

Tanaka Building
Exhibition Rd
London, SW7 2AZ
United Kingdom

HOME PAGE: http://www.harjoatbhamra.com

Christian Dorion

HEC Montreal ( email )

3000, Chemin de la Côte-Sainte-Catherine
Montreal, Quebec H2X 2L3
Canada
5143401522 (Phone)
5143405632 (Fax)

HOME PAGE: http://neumann.hec.ca/pages/christian.dorion/

Canadian Derivatives Institute ( email )

3000, chemin de la Côte-Sainte-Catherine
Montréal, Québec H3T 2A7
Canada

Alexandre Jeanneret

UNSW Business School ( email )

Sydney, NSW 2052
Australia

Michael Weber (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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