Firm Characteristics, Unanticipated Inflation, and Stock Returns

Authors

  • DOUGLAS K. PEARCE,

  • V. VANCE ROLEY

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    • Pearce is from the Department of Economics and Business, North Carolina State University. Roley is from the Department of Finance, University of Washington and the National Bureau of Economic Research. The authors are grateful to Michael Gilberto for research assistance and to Steven Allen, John Campbell, Heidi Chrisman, Diana Hancock, Paul Malatesta, James Pesando, Simon Wheatley, and a referee for helpful comments. Research support from the Center for the Study of Banking and Financial Markets, University of Washington, and Rainier National Bank is gratefully acknowledged


ABSTRACT

This paper re-examines the effects of nominal contracts on the relationship between unanticipated inflation and an individual stock's rate of return. This study differs in three main ways from previous research. First, announced inflation data are used to examine the effects of unanticipated inflation. Second, a different specification is used to obtain more efficient estimates. Third, additional nominal contracts are considered. The empirical results indicate that time-varying firm characteristics related to inflation predominately determine the effect of unanticipated inflation on a stock's rate of return. A firm's debt-equity ratio appears to be particularly important in determining the response.

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