Real Basis Risk and Long-Horizon Inflation Hedging

Damiaan Chen, Roel Beetsma and Sweder van Wijnbergen

No 22011, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Inflation-linked bonds (ILBs) are indexed to official consumer prices, but the inflation exposure of long-horizon investors may differ from that index. We study how this "real basis risk" shapes optimal allocations to nominal government bonds, ILBs, and equities for investors resident in Germany, the Netherlands, the United Kingdom, and the United States. We document substantial cross-country heterogeneity in hedge effectiveness and optimal portfolios and show that real basis risk and its covariance with inflation determine the substitution between nominal bonds and ILBs. The welfare benefits of access to each asset class differ markedly across countries. The results imply that inflation risk persists over long horizons, despite investments in ILBs.

Keywords: Unhedgeable; inflation; risk (search for similar items in EconPapers)
JEL-codes: C61 E21 G11 G23 (search for similar items in EconPapers)
Date: 2026-10
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