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We develop an asset pricing model with endogenous corporate policies that explains how inflation jointly affects real asset prices and corporate default risk. Our model includes two empirically founded nominal rigidities: fixed nominal debt coupons (sticky leverage) and sticky cash flows. These two frictions result in lower real equity prices and credit spreads when expected inflation rises. A decrease in expected inflation has opposite effects, with even larger magnitudes. In the cross-section, the model predicts that the negative impact of higher expected inflation on real equity values is stronger for low leverage firms. We find empirical support for the model's predictions. Authors have furnished an Internet Appendix , which is available on the Oxford University Press Web site next to the link to the final published paper online. [ABSTRACT FROM AUTHOR]

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jedc.2005.04.001 Byline: Harjoat S. Bhamra (a), Raman Uppal (b)(c) Abstract: Our objective is to understand how risk aversion and elasticity of intertemporal substitution under recursive utility affect dynamic consumption-portfolio decisions. For a three-date model with a stochastic interest rate, we obtain an analytic solution for the optimal policies. We find that, in general, consumption and portfolio decisions depend on both risk aversion and elasticity of intertemporal substitution. The size of risk aversion relative to unity determines the sign of the intertemporal hedging portfolio, while elasticity of intertemporal substitution affects only its magnitude. The portfolio weight is independent of elasticity of intertemporal substitution only for the case of a constant investment opportunity set. Author Affiliation: (a) Sauder School of Business, University of British Columbia, 2053 Main Mall, Vancouver BC, Canada V6T 1Z2 (b) London Business School, Sussex Place, Regent's Park, London NW1 4SA, UK (c) Center for Economic Policy Research, 90-98 Goswell Road, London EC1V 7RR, UK Article History: Received 17 August 2004; Accepted 7 April 2005