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Inflation and Nominal Financial Reporting: Implications for Performance and Stock Prices

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  • Konchitchki, Yaniv

Abstract

The monetary unit assumption of financial accounting assumes a stable currency (i.e., constant purchasing power over time). Yet, even during periods of low inflation or deflation, nominal financial statements violate this assumption. I posit that, while the effects of inflation are not recognized in nominal statements, such effects may have economic consequences. I find that unrecognized inflation gains and losses help predict future cash flows as these gains and losses turn into cash flows over time. I also find significant abnormal returns to inflation-based trading strategies, suggesting that stock prices do not fully reflect the implications of the inflation effects for future cash flows. Additional analysis reveals that stock prices act as if investors do not fully distinguish monetary and nonmonetary assets, which is fundamental to determining the effects of inflation. Overall, this study is the first to show that, although inflation effects are not recognized in nominal financial statements, they have significant economic consequences, even during a period in which inflation is relatively low.

Suggested Citation

  • Konchitchki, Yaniv, 2011. "Inflation and Nominal Financial Reporting: Implications for Performance and Stock Prices," MPRA Paper 52928, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:52928
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    File URL: https://mpra.ub.uni-muenchen.de/52928/2/MPRA_paper_52928.pdf
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Vali Khodadadi & Ali Vaez & Hashem Alisufi, 2014. "Investigating the Effect of Inflation Disclosure on Improving the Information Content of the Financial Reporting," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 5(3), pages 96-109, July.
    2. Barth, Mary E. & Konchitchki, Yaniv & Landsman, Wayne R., 2013. "Cost of capital and earnings transparency," Journal of Accounting and Economics, Elsevier, vol. 55(2), pages 206-224.
    3. Yaniv Konchitchki & Yan Luo & Mary L. Z. Ma & Feng Wu, 2016. "Accounting-based downside risk, cost of capital, and the macroeconomy," Review of Accounting Studies, Springer, vol. 21(1), pages 1-36, March.
    4. Konchitchki, Yaniv & Patatoukas, Panos N., 2014. "Accounting earnings and gross domestic product," Journal of Accounting and Economics, Elsevier, vol. 57(1), pages 76-88.
    5. Konchitchki, Yaniv, 2013. "Accounting and the Macroeconomy: The Case of Aggregate Price-Level Effects on Individual Stocks," MPRA Paper 52934, University Library of Munich, Germany.
    6. Yaniv Konchitchki, 2016. "Accounting Valuation and Cost of Capital Dynamics: Theoretical and Empirical Macroeconomic Aspects. Discussion of Callen," Abacus, Accounting Foundation, University of Sydney, vol. 52(1), pages 26-34, March.
    7. Juneja, Januj, 2014. "Term structure estimation in the presence of autocorrelation," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 119-129.
    8. Li, Ningzhong & Richardson, Scott & Tuna, İrem, 2014. "Macro to micro: Country exposures, firm fundamentals and stock returns," Journal of Accounting and Economics, Elsevier, vol. 58(1), pages 1-20.
    9. repec:kob:tjrevi:dec2016:v:6:p:95-122 is not listed on IDEAS

    More about this item

    Keywords

    inflation; asset pricing; information; financial reporting; abnormal returns; cash flows; capital markets;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • M1 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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