Time-Varying Inflation Risk and Stock Returns - FEDERAL RESERVE BANK of NEW YORK

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Time-Varying Inflation Risk and Stock Returns

Previous title: "Time-Varying Inflation Risk and the Cross Section of Stock Returns"

May 2013 Number 621
Revised April 2019

JEL classification: G11, G12, G13

Author: Martijn Boons, Fernando M. Duarte, Frans de Roon, and Marta Szymanowska

We show that inflation risk is priced in stock returns and that inflation risk premia in the cross-section and the aggregate market vary over time, even changing sign as in the early 2000s. This time variation is due to both price and quantities of inflation risk changing over time. Using a consumption-based asset pricing model, we argue that inflation risk is priced because inflation predicts real consumption growth. The historical changes in this predictability and in stocks' inflation betas can account for the size, variability, predictability and sign reversals in inflation risk premia.

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