We show that inflation risk is priced into stock returns and that inflation 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.
- time-varying inflation risk premium
- inflation hedging
- cross-sectional asset pricing
- nominal-real covariance