Flow-through capability: The Spanish case

Abstract

Thus, the paper is organised into three parts. The first part looks at the main stock interest risk assessment models. The second part revises previous literature on the Fisher effect, in order to check whether the majority of nominal interest rate movements are caused by inflation rate fluctuations, the real interest rate remaining constant. The final part shows the empirical analysis aimed at estimating the flow-through coefficients of the Spanish companies and sets out the empirical results. Literature reviewThe current literature attempts to extend the concept of bond duration to equities. For instance, Leibowitz and Martin (1986) estimate the interest rate sensitivity of the US equity market. The basic model from which this paper starts is the dividend discount model (DDM) Abstract This paper analyses the repercussion of variations in interest rates on quoted stocks. First, it reviews the main models of interest risk assessment, whose basic tool is the stock duration, that is, the sensitivity of the stock price to movements in nominal interest rates. It also analyses the main criticism concerning these models. Secondly, it estimates the capability of Spanish companies to pass inflation changes on to product or services prices.

Spanish stock market sensitivity to real interest and inflation rates: an extension of the Stone two-factor model with factors of the Fama and French three-factor model

“…Besides, the smallest companies present a higher return than the biggest companies, being the average value about 0.7185. Sectorially, "Oil and 8 This result is consistent with a previous study (Jareño, 2005), in which "Oil and Energy" shows a high flow-through capability. Finally, the growth factor shows a lower percentage of companies with statistical significance (36 %).…”

“…As regards the movements of the real interest rates, the results confirm the state services" sector, seem to have a strong "flow-through capability" (Jareño, 2005).…”

Investor Behavior and Flow-through Capability in the US Stock Market

“…Empirical evidence (Jareño, 2005 ; Jareño and Navarro, 2010 ) suggests that FTC has an effect on stock prices and that there are significant differences in FTC at the sector level. Namely, industries in which the flow-through (FT) coefficients are greater exhibit stock prices that are less sensitive to inflation shocks.…”

European Inflation and the Spanish Stock Market

“…By contrast, Estep and Hanson (1980) propose that the relationship between stock returns and unexpected inflation news depends on the ability of firms to transmit inflation shocks to the prices of the products and services sold by the company -"flowthrough hypothesis"- (Asikoglu and Ercan, 1992;Jareño, 2005;Jareño and Navarro, 2010;and Díaz and Jareño, 2013). Companies with a high flow-through coefficient should have the ability to reflect inflation rate changes in their product prices and thus "flow through" the effects of inflation to customers.…”