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Inflation-hedging portfolios in Different Regimes

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  • Marie Briere
  • Ombretta Signori

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.

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Bibliographic Info

Paper provided by ULB -- Universite Libre de Bruxelles in its series Working Papers CEB with number 09-047.RS.

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Length: 41 p.
Date of creation: 2009
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Publication status: Published by:
Handle: RePEc:sol:wpaper:09-047

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Keywords: inflation hedge; pension finance; shortfall risk; portfolio optimisation;

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Cited by:
  1. Fulli-Lemaire, Nicolas, 2013. "Alternative inflation hedging strategies for ALM," MPRA Paper 43755, University Library of Munich, Germany.
  2. Brière, Marie & Ang, Andrew & Signori, Ombretta, 2012. "Inflation and Individual Equities," Economics Papers from University Paris Dauphine 123456789/7847, Paris Dauphine University.
  3. Fulli-Lemaire, Nicolas, 2012. "Allocating Commodities in Inflation Hedging Portfolios: A Core Driven Global Macro Strategy," MPRA Paper 42852, University Library of Munich, Germany, revised 15 Oct 2012.
  4. Fulli-Lemaire, Nicolas, 2012. "A Dynamic Inflation Hedging Trading Strategy Using a CPPI," MPRA Paper 42851, University Library of Munich, Germany, revised 13 Nov 2012.

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