Stock prices and inflation hedged firms

ABSTRACT

As the Federal Reserve continues its near-zero rate policy, the threat of inflation remains a concern among both policymakers and businesses. This article uses over 30 years of accounting data and stock returns to examine how publicly traded firms respond to increasing inflation expectations. We first examine whether firms make balance sheet adjustments in response to expected inflation. We then examine whether these activities have a positive effect on stock prices. We find that firms increase inventory, increase capital expenditures and reduce long-term debt when there is an increased expectation of inflation. We then find that firms that increase inventory in this economic regime are rewarded in the market. Markets also reward firms that increase their cash positions and reduce long-term debt possibly suggesting investor flight to safety.

KEYWORDS:

• Monetary policy
• financial markets
• factor models
• capital budgeting

JEL CLASSIFICATION:

• E44
• E52
• E58
• G31

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ See Fama (1981) for a review of the literature up to that point and a discussion of the puzzling and sometimes conflicting findings.

² Federal Reserve Bank of Cleveland data begins in year 1981.

³ We remove all debt ratios not between 0 and 1.