Inflation Expectations and Stock Returns

51 Pages Posted: 18 Jul 2022 Last revised: 24 May 2024

See all articles by Manav Chaudhary

Manav Chaudhary

University of Chicago - Booth School of Business; University of Chicago - Department of Economics

Benjamin Marrow

University of Chicago - Booth School of Business; University of Chicago - Department of Economics

Date Written: July 5, 2022

Abstract

How do inflation expectations affect stock returns, and what accounts for this relationship? We directly measure investors' expectations using traded inflation-indexed contracts and show that, post-2000, stocks offer positive returns in response to higher expected inflation: unconditionally, a 10 basis point increase in 10-year breakeven inflation is associated with a 1.1\% increase in the value-weighted stock index. Using a wide range of approaches, we show that this positive relationship is almost entirely due to aggregate variations in expected excess returns rather than changes in firm cash flows (e.g., due to higher mark-ups) or fluctuations in risk-free rates (e.g., due to expected monetary policy response). Overall, a risk premium ``proxy'' mechanism appears to explain this dominant role of expected excess returns: higher long-term inflation expectations signal stronger future economic growth and reduced volatility.

Keywords: Inflation Expectations, Stock Returns, Expected Excess Returns

JEL Classification: G14, E31, E44

Suggested Citation

Chaudhary, Manav and Marrow, Benjamin, Inflation Expectations and Stock Returns (July 5, 2022). Available at SSRN: https://ssrn.com/abstract=4154564 or http://dx.doi.org/10.2139/ssrn.4154564

Manav Chaudhary (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S Woodlawn Ave
Chicago, IL 60637
United States

University of Chicago - Department of Economics ( email )

1101 East 58th Street
Chicago, IL 60637
United States

Benjamin Marrow

University of Chicago - Booth School of Business ( email )

5807 S Woodlawn Ave
Chicago, IL 60637
United States

University of Chicago - Department of Economics ( email )

1101 East 58th Street
Chicago, IL 60637
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
1,352
Abstract Views
3,779
Rank
28,494
PlumX Metrics