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Optimal portfolio choice in real terms: Measuring the benefits of TIPS

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  • Cartea, Álvaro
  • Saúl, Jonatan
  • Toro, Juan

Abstract

In this paper we solve an optimal portfolio choice problem to measure the benefits of Treasury Inflation Indexed Securities (TIPS) to investors concerned with maximizing real wealth. We show how the introduction of a real riskless asset completes the investor asset space, by contrasting optimal portfolio allocations with and without such assets. We use historical data to quantify gains from availability of TIPS in the presence of other asset classes such as equities, commodities, and real estate. We draw a distinction between buy-and-hold long-term investors for whom TIPS fully displace nominal risk-free assets and short-term investors for whom TIPS improve the investment opportunity set of real returns. Finally, we show how gains from TIPS are tempered by the availability of alternative assets that covary with inflation, such as gold and real estate.

Suggested Citation

  • Cartea, Álvaro & Saúl, Jonatan & Toro, Juan, 2012. "Optimal portfolio choice in real terms: Measuring the benefits of TIPS," Journal of Empirical Finance, Elsevier, vol. 19(5), pages 721-740.
    • Handle: RePEc:eee:empfin:v:19:y:2012:i:5:p:721-740
    DOI: 10.1016/j.jempfin.2012.08.002
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    Cited by:

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    2. Mkaouar, Farid & Prigent, Jean-Luc & Abid, Ilyes, 2017. "Long-term investment with stochastic interest and inflation rates: The need for inflation-indexed bonds," Economic Modelling, Elsevier, vol. 67(C), pages 228-247.
    3. Dewandaru, Ginanjar & Masih, Rumi & Bacha, Obiyathulla Ismath & Masih, A. Mansur M., 2017. "The role of Islamic asset classes in the diversified portfolios: Mean variance spanning test," Emerging Markets Review, Elsevier, vol. 30(C), pages 66-95.
    4. Farid Mkaouar & Jean-Luc Prigent & Ilyes Abid, 2019. "A Diffusion Model for Long-Term Optimization in the Presence of Stochastic Interest and Inflation Rates," Computational Economics, Springer;Society for Computational Economics, vol. 54(1), pages 367-417, June.
    5. Swinkels, Laurens, 2018. "Simulating historical inflation-linked bond returns," Journal of Empirical Finance, Elsevier, vol. 48(C), pages 374-389.
    6. Philipp Karl Illeditsch, 2018. "Residual Inflation Risk," Management Science, INFORMS, vol. 64(11), pages 5289-5314, November.

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    More about this item

    Keywords

    Portfolio choice in real terms; Treasury Inflation Indexed Securities (TIPS); Buy-and-hold long-term investors; Money illusion;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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