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Inflation risk and the inflation risk premium

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  • Geert Bekaert
  • Xiaozheng Wang

Abstract

"This article starts by discussing the concept of 'inflation hedging' and provides estimates of 'inflation betas' for standard bond and well-diversified equity indices for over 45 countries. We show that such standard securities are poor inflation hedges. Expanding the menu of assets to Treasury bills, foreign bonds, real estate and gold improves matters but inflation risk remains difficult to hedge. We then describe how state-of-the-art term structure research has tried to uncover estimates of the inflation risk premium, the compensation for bearing inflation risk. Most studies, including very recent ones that actually use inflation-linked bonds and information in surveys to gauge inflation expectations, find the inflation risk premium to be sizeable and to substantially vary through time. This implies that governments should normally lower their financing costs through the issuance of index-linked bonds, at least in an ex ante sense. Our findings thus indicate a potentially important role for inflation index linked bonds. We briefly discuss the pros and cons of such bonds, focusing the discussion mostly on the situation in the United States, which started to issue Treasury Inflation Protected Securities (TIPS) in 1997. We argue that it is hard to negate the benefits of such securities for all relevant parties, unless the market in which they trade is highly deficient, which was actually the case in its early years in the United States." Copyright (c) CEPR, CES, MSH, 2010.

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Bibliographic Info

Article provided by CEPR & CES & MSH in its journal Economic Policy.

Volume (Year): 25 (2010)
Issue (Month): (October)
Pages: 755-806

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Handle: RePEc:bla:ecpoli:v:25:y:2010:i::p:755-806

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References

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Citations

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Cited by:
  1. Grishchenko, Olesya V., 2011. "Asset pricing in the production economy subject to monetary shocks," Journal of Economics and Business, Elsevier, vol. 63(3), pages 187-216, May.
  2. Christopher T. Downing & Francis A. Longstaff & Michael A. Rierson, 2012. "Inflation Tracking Portfolios," NBER Working Papers 18135, National Bureau of Economic Research, Inc.
  3. Hatcher, Michael, 2013. "The Inflation Risk Premium on Government Debt in an Overlapping Generations Model," SIRE Discussion Papers 2013-81, Scottish Institute for Research in Economics (SIRE).
  4. Michael Hatcher, 2013. "Aggregate and welfare effects of long run inflation risk under inflation and price-level targeting," Working Papers 2013_03, Business School - Economics, University of Glasgow.
  5. Andrew Ang & Marie Brière & Ombretta Signori, 2012. "Inflation and Individual Equities," NBER Working Papers 17798, National Bureau of Economic Research, Inc.
  6. Tomek Katzur & Laura Spierdijk, 2013. "Stock returns and inflation risk: economic versus statistical evidence," Applied Financial Economics, Taylor & Francis Journals, vol. 23(13), pages 1123-1136, July.
  7. Asgharian, Hossein & Hess, Wolfgang & Liu, Lu, 2013. "A spatial analysis of international stock market linkages," Knut Wicksell Working Paper Series 2013/3, Knut Wicksell Centre for Financial Studies, Lund University.
  8. Hatcher, Michael C., 2011. "Comparing inflation and price-level targeting: A comprehensive review of the literature," Cardiff Economics Working Papers E2011/22, Cardiff University, Cardiff Business School, Economics Section.
  9. Anginer, Deniz & Demirguc-Kunt, Asli, 2011. "Has the global banking system become more fragile over time ?," Policy Research Working Paper Series 5849, The World Bank.
  10. Claude B. Erb & Campbell R. Harvey, 2013. "The Golden Dilemma," NBER Working Papers 18706, National Bureau of Economic Research, Inc.
  11. Brière, Marie & Signori, Ombretta, 2013. "Hedging inflation risk in a developing economy: The case of Brazil," Research in International Business and Finance, Elsevier, vol. 27(1), pages 209-222.

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