On the Limits of Hedging Inflation Risk in Investment Portfolios

Damiaan Chen, Roel Beetsma and Sweder van Wijnbergen

Working Papers from DNB

Abstract: We explore to what extent real returns on investment portfolios can be hedged against inflation risk by using existing financial market instruments. We empirically find that inflation-linked bonds offer only limited protection against inflation risk, while nominal debt and stocks play at least comparable roles in this respect. These findings apply to both a static and a dynamic setting. To explain the empirical results, we develop a theoretical framework that incorporates real basis risk. The demonstrated limits of hedging inflation risk are of particular relevance for long-term investors, such as pension funds with participants concerned about the real value of their pension benefits.

Keywords: unhedgeable inflation risk; incomplete markets; welfare loss; meanvariance frontiers; minimum-variance portfolio; nominal and index-linked bonds (search for similar items in EconPapers)
JEL-codes: C61 E21 G11 G23 (search for similar items in EconPapers)
Date: 2026-04
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