Good Inflation, Bad Inflation: Implications for Risky Asset Prices

71 Pages Posted: 18 Apr 2024 Last revised: 13 Jan 2025

See all articles by Diego Bonelli

Diego Bonelli

Banco de España

Berardino Palazzo

Board of Governors of the Federal Reserve System

Ram Yamarthy

Board of Governors of the Federal Reserve System

Date Written: January 01, 2025

Abstract

Using inflation swap prices, we study how changes in expected inflation affect firm-level credit spreads and equity returns, and uncover evidence of a time-varying inflation sensitivity. In times of “good inflation,” when inflation news is perceived by investors to be more positively correlated with real economic growth, movements in expected inflation substantially reduce corporate credit spreads and raise equity valuations. Meanwhile in times of “bad inflation,” these effects are attenuated and the opposite can take place. These dynamics naturally arise in an equilibrium asset pricing model with a time-varying inflation-growth relationship and persistent macroeconomic expectations.

Keywords: Time Variation, Asset Prices, Stock-Bond Correlation, Inflation Sensitivity

JEL Classification: E31, E44, G12

Suggested Citation

Bonelli, Diego and Palazzo, Berardino and Yamarthy, Ram, Good Inflation, Bad Inflation: Implications for Risky Asset Prices (January 01, 2025). Available at SSRN: https://ssrn.com/abstract=4798269 or http://dx.doi.org/10.2139/ssrn.4798269

Diego Bonelli

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

Berardino Palazzo

Board of Governors of the Federal Reserve System ( email )

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

Ram Yamarthy (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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

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