Product Price Change Timing and Stock Returns

Abstract

Firms with low price change frequency conditional on large macroeconomic shocks earn a risk premium not explained by unconditional frequency of price adjustments. I build a multisector model in which firms face heterogeneous types of nominal rigidities. Firms that are more likely to change their price when the cost of their price gap is high have higher conditional frequencies of price changes after large aggregate shocks. This higher conditional price change frequency after large shocks reduces systematic risk, lowering average equity returns. I test the predictions of the model by creating a new dataset that links firms from Compustat to weekly grocery store scanner data. I demonstrate that a common proxy for price change frequency conditional on price gap size, the kurtosis of price changes, carries a risk premium of 6% in the post-2005 period, validating the model.

Keywords: nominal rigidities, stock returns, asset pricing