Tests of the Nominal Contracting Hypothesis Using Stocks and Bonds of the Same Firms

Abstract

We test the nominal contracting hypothesis by examining the price responses of stocks and long-term bonds issued by the same firms to inflation surprises. We fail to find evidence that unexpected inflation transfers wealth to real from nominal contract holders, i.e., to stockholders from bondholders. An alternative interpretation of previous tests that seemingly support the nominal contracting hypothesis is proposed, based on firms' asset rather than liability structures. Our test results and alternative interpretation suggest caution in ascribing to nominal contracts major intrafirm wealth redistributions due to unexpected inflation.