Exploring Cross-Sectional Effects of Inflation

The US generally accepted accounting principles (GAAP) do not require adjustments for inflation, so financial statements are reported in nominal terms. This struck Yaniv Konchitchki as problematic. In his article “Accounting and the Macroeconomy: The Case of Aggregate Price-Level Effects on Individual Stocks,” published in the November/December 2013 issue of the Financial Analysts Journal, Konchitchki examines stock-valuation effects of aggregate price-level changes on individual companies. He shares his thoughts about his work in the latest installment of our FAJ author interview series.

“Inflation affects all assets and liabilities; therefore, even low inflation leads to major economic effects on firms,” he says. Konchitchki’s research shows that inflation-based investment strategies conditioned on available information result in significant risk-adjusted returns.

Furthermore, he demonstrates that investing using the inflation effect on companies’ net monetary holdings results in insignificant abnormal hedge returns, whereas investing using the inflation effect on companies’ nonmonetary holdings consistently yields economically and statistically significant hedge returns.

Konchitchki says his research has important implications for valuation. Noting that he provides algorithms that can be adjusted for specific firms and shows how investors can benefit from these adjustments, Konchitchki points out that it is now possible to adjust for inflation without waiting on the US SEC to impose an inflation-adjusted reporting regime.

To hear Konchitchki discuss his research further, listen to the full interview (above) or download the MP3.

CFA Institute members can access the full article on the CFA Publications website.

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