Stagflationary Stock Returns and the Role of Market Power

Abstract

We study the inflation implications for firms across the market power distribution from an asset pricing perspective. Inflationary surprises are associated with persistent declines in stock returns. Decomposing the present value identity of stock prices, we show that investors expect nominal cashflows to remain stagnant during periods of higher-than-expected inflation, a stagflationary view of the world, on average. However, we find that firms with a large degree of market power are shielded from the negative returns following inflation surprises, as market power firms are expected to generate a relative increase in their nominal cashflows in response to inflation shocks.

Keywords: Inflation, Stock Returns, Market Power, Stagnant Cashflows

JEL Classification: G12, E31, E44, L11