Stagflationary Stock Returns

79 Pages Posted: 20 Aug 2023 Last revised: 19 Apr 2024

See all articles by Benjamin Knox

Benjamin Knox

Board of Governors of the Federal Reserve System

Yannick Timmer

International Monetary Fund (IMF) - Research Department; Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: August 15, 2023

Abstract

We study investors' perceptions of inflation through the lens of a high-frequency event study and document that they have a stagflationary view of the world. In response to higher-than-expected inflation, investors expect firms' nominal cash flows to remain stagnant while discount rates increase, resulting in lower stock prices. Both the equity risk premium and nominal risk-free yields rise. However, longer-term real yields remain unchanged, and policy-sensitive real yields even decline, with increases in nominal yields offset by larger increases in inflation expectations. Consistent with a stagflationary view in which investors interpret inflation as a marginal cost shock, investors expect firms with low market power to suffer larger declines in cash flows. Cash flow expectations of equity investors are aligned with those of professional earnings analysts, both in the time series and across the market power distribution.

Keywords: G12, E31, E44, L11 Inflation, Stock Returns, Stagnant Cash Flows, Market Power

JEL Classification: G12, E31, E44, L11

Suggested Citation

Knox, Benjamin and Timmer, Yannick, Stagflationary Stock Returns (August 15, 2023). Available at SSRN: https://ssrn.com/abstract=4541860 or http://dx.doi.org/10.2139/ssrn.4541860

Benjamin Knox (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Yannick Timmer

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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