Inflation has an indirect effect on price-earnings ratios through its impact on Ke.

Question

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Inflation affects the discount rate, Ke or cost of equity, which is a crucial factor in determining the price-earnings ratio of a company or the overall market. With an increase in inflation, the risk-free rate of return adjusts upwards, leading to higher expected returns from the market, hence increasing Ke. As higher Ke leads to a lower price-earnings ratio, inflation affects price-earnings ratios indirectly through its impact on Ke.

Inflation Has an Indirect Effect on Price-Earnings Ratios Through Its