Low Inflation: High Default Risk and High Equity Valuations

78 Pages Posted: 3 Dec 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 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 effects, 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.

Suggested Citation

Bhamra, Harjoat Singh and Dorion, Christian and Jeanneret, Alexandre and Weber, Michael, Low Inflation: High Default Risk and High Equity Valuations (November 2018). NBER Working Paper No. w25317, Available at SSRN: https://ssrn.com/abstract=3294920

Harjoat Singh Bhamra (Contact Author)

Imperial College Business School ( email )

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Christian Dorion

HEC Montreal ( email )

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

Alexandre Jeanneret

HEC Montréal ( email )

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Montreal, Quebec H3T 2A7
Canada

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

Michael Weber

University of Chicago - Finance ( email )

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Chicago, IL 60637
United States

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