Inflation-hedging portfolios in Different Regimes

Marie Brière () and Ombretta Signori ()

No 09-047.RS, Working Papers CEB from ULB -- Universite Libre de Bruxelles

Abstract: The unconventional monetary policies implemented in the wake of the subprime crisis and the recent increase in inflation volatility have revived the debate on medium to long-term resurgence of inflation. This paper presents the optimal strategic asset allocation of an investor seeking to hedge inflation risk in different macroeconomic regimes. Using a vector-autoregressive model (VAR) for the joint dynamics of asset returns, inflation and other state variables, we investigate in the context of a simulation that allows for serial and cross-sectional inter-temporal dependencies the relationship between asset returns and different economic variables, at different investment horizons. We then study the optimal portfolio choice for the investor seeking to attain a fixed target for real returns on his investment horizon, with a shortfall probability constraint. We show that the strategic asset allocation differs sharply across regimes. In a volatile macroeconomic environment, inflation-linked bonds, equities, commodities and real estate play all an essential role in hedging a portfolio against inflation. In a more stable economic environment (“Great Moderation”), nominal bonds play the most significant role, with equities and commodities. An ambitious investor in terms of required real return should have a larger weighting in risky assets, especially commodities. We show the optimal allocation for each investor, depending on his target real return and tolerated shortfall probability.

Keywords: inflation hedge; pension finance; shortfall risk; portfolio optimisation (search for similar items in EconPapers)
JEL-codes: E31 G11 G12 G23 (search for similar items in EconPapers)
Pages: 41 p.
Date: 2009
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Citations: View citations in EconPapers (3)

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Chapter: Inflation hedging portfolios in different regimes (2011)
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