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Inflation illusion and stock returns

Author

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  • Brown, William O.
  • Huang, Dayong
  • Wang, Fang

Abstract

A large sensitivity of stocks' earnings yield to inflation suggests that the value of these stocks is highly influenced by inflation illusion. We construct an inflation illusion factor by buying stocks with large earnings yield sensitivities on inflation and selling stocks with small earnings yield sensitivities on inflation. This factor has a return of approximately 5% per year and is priced in the cross sectional asset returns. Low asset growth stocks have greater exposure to the inflation illusion factor than their counterparts, and they are also underpriced at times of high inflation. Our results are robust for a number of controls.

Suggested Citation

  • Brown, William O. & Huang, Dayong & Wang, Fang, 2016. "Inflation illusion and stock returns," Journal of Empirical Finance, Elsevier, vol. 35(C), pages 14-24.
    • Handle: RePEc:eee:empfin:v:35:y:2016:i:c:p:14-24
    DOI: 10.1016/j.jempfin.2015.11.001
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    More about this item

    Keywords

    Inflation illusion; Mispricing; Dividend yields;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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