Low Inflation: High Default Risk AND High Equity Valuations

79 Pages Posted: 29 Nov 2018

See all articles by Harjoat Singh Bhamra

Harjoat Singh Bhamra

Imperial College Business School

Christian Dorion

HEC Montreal

Alexandre Jeanneret

HEC Montréal

Michael Weber

University of Chicago - Finance

Multiple version iconThere are 3 versions of this paper

Date Written: November 26, 2018

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 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 e ffects, 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.

Keywords: low 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, Low Inflation: High Default Risk AND High Equity Valuations (November 26, 2018). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2018-81. Available at SSRN: https://ssrn.com/abstract=3292395 or http://dx.doi.org/10.2139/ssrn.3292395

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/

Alexandre Jeanneret

HEC Montréal ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

HOME PAGE: http://www.alexandrejeanneret.net

Michael Weber (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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