Downward Nominal Price Rigidity and Earnings Persistence

Abstract

Does nominal price rigidity spread to equity markets? I use a fuzzy regression discontinuity design to show that company operating income is less persistent when input prices decrease than when input prices increase by the same size. This asymmetry arises because nominal prices for outputs are downwardly rigid. Analysts incorporate this asymmetric effect on income persistence in their forecasts with a delay. Firms that receive downward (upward) shocks to input costs experience negative (positive) return drift following earnings announcements. The findings suggest that, through the channel of price rigidity, small nominal shocks can have a large impact on stock prices.