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Investment Strategy in an Inflationary Environment

In: The Changing Roles of Debt and Equity in Financing U.S. Capital Formation

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  • Zvi Bodie

Abstract

This paper addresses the issue of how an investor concerned about the real rate of return on his investment portfolio should allocate his funds among four major asset classes: stocks, bonds, bills and commodity futures contracts. It employs the Markowitz mean-variance framework to derive estimates of the pre-tax, real risk-return tradeoff curve currently facing an investor in the U.S. capital markets. Some of the major findings are: 1) Bills are the cornerstone of any low-risk investment strategy. The minimum-risk portfolio has a mean real rate of return of zero and a standard deviation of about 1%. The slope of the tradeoff curve is initially 1, but it declines rapidly as one progresses up the curve to higher mean rates of return. 2) Stocks offer the highest mean and are also riskiest. 3) Bonds play a prominent part in portfolios which lie in the midsection of the tradeoff curve, although not much would be lost if these instruments were eliminated. 4) Commodity futures contracts are the only asset whose returns are positively correlated with inflation. By adding them to the portfolios of stocks, bonds and bills, it is possible to achieve any target mean real rate of return with less risk.

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This chapter was published in:

  • Benjamin M. Friedman, 1982. "The Changing Roles of Debt and Equity in Financing U.S. Capital Formation," NBER Books, National Bureau of Economic Research, Inc, number frie82-1, octubre-d.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 11394.

    Handle: RePEc:nbr:nberch:11394

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    Cited by:
    1. Benjamin M. Friedman, 1983. "The Substitutability of Debt and Equity Securities," NBER Working Papers 1130, National Bureau of Economic Research, Inc.
    2. King, Mervyn A. & Leape, Jonathan I., 1998. "Wealth and portfolio composition: Theory and evidence," Journal of Public Economics, Elsevier, vol. 69(2), pages 155-193, June.
    3. Lawrence H. Summers, 1983. "Observations on the Indexation of Old Age Pensions," NBER Chapters, in: Financial Aspects of the United States Pension System, pages 231-258 National Bureau of Economic Research, Inc.
    4. Zvi Bodie, 1989. "Inflation Insurance," NBER Working Papers 3009, National Bureau of Economic Research, Inc.
    5. Mervyn A. King & Jonathan I. Leape, 1984. "Wealth and Portfolio Composition: Theory and Evidence," NBER Working Papers 1468, National Bureau of Economic Research, Inc.

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