Working Paper

“Good” Inflation, “Bad” Inflation: Implications for Risky Asset Prices

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: Inflation Sensitivity; Time Variation; Asset Prices; Stock-Bond Correlation;

JEL Classification: E31; E44; G12;

https://doi.org/10.17016/FEDS.2025.002

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2025-01-06

Number: 2025-002