Inflation Illusion and the (Mis) Pricing of Assets and Liabilities

Abstract

Inflation, crucial to people's economic and financial decisions, is often handled improperly in conventional valuation frameworks. Forecasts of future nominal cash flows are not always based on the same expected rate of inflation that is in the nominal interest rate used to discount those cash flows. This can lead to mispricing of assets and liabilities, especially when nominal interest rates and expected inflation move outside recent norms.