Stock interest rate risk and inflation shocks

In this paper we proceed to estimate a measure of the flow-through capability of the firms listed in the Spanish Stock Exchange. The flow-through capability is defined as the ability of firms to transmit inflation shocks to the prices of the products and services sold by the company. According to a strand of literature, this flow-through capability can explain, to some extent, the so called “stock duration paradox”, that is the difference between the theoretical stock duration derived from the DDM model and its empirical estimates. The line of reasoning suggest that if a company can pass on inflation shocks to the prices of its own outputs and then to profits and dividends, nominal interest rate changes due to variations in the expected inflation will have a limited impact on stock prices. So in this paper we first estimate the flow-trough capability for different industries finding strong differences among them. Then, we analyse the link between flow-through capability and stock duration finding a significant negative relationship between them as claimed by part of the literature.