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Do Inflation-Linked Bonds Still Diversify?

Author

Listed:
  • Marie Brière
  • Ombretta Signori

Abstract

"The diversifying power of inflation-linked (IL) bonds relative to traditional asset classes has changed significantly. In this paper, we study the dynamics of conditional volatilities and correlations for three asset classes, IL bonds, nominal bonds and equities, in the USA and Europe. Using a DCC-MVGARCH for the period 1997-2007, we highlight the change that took place in 2003. Although IL bonds once had definite diversification power, they are now highly correlated with nominal bonds and have reached similar volatility levels. As a result, the two asset classes are practically substitutable. This seems to be due to more stable inflation expectations and to a more liquid IL bond market. Although diversification was a valuable reason for introducing IL bonds in a global portfolio before 2003, this is no longer the case. Dynamic portfolio optimisation using our estimates of conditional correlations and volatilities clearly demonstrates that the optimal weight of IL bonds in a portfolio decreased sharply in 2003 in favour of nominal bonds and equities." Copyright (c) 2008 The Authors Journal compilation (c) 2008 Blackwell Publishing Ltd.

Suggested Citation

  • Marie Brière & Ombretta Signori, 2009. "Do Inflation-Linked Bonds Still Diversify?," European Financial Management, European Financial Management Association, vol. 15(2), pages 279-297.
  • Handle: RePEc:bla:eufman:v:15:y:2009:i:2:p:279-297
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    References listed on IDEAS

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    1. Ben S. Bernanke, 2006. "Reflections on the yield curve and monetary policy," Speech 175, Board of Governors of the Federal Reserve System (U.S.).
    2. Robert F. Engle & Kevin Sheppard, 2001. "Theoretical and Empirical properties of Dynamic Conditional Correlation Multivariate GARCH," NBER Working Papers 8554, National Bureau of Economic Research, Inc.
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    Citations

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    Cited by:

    1. Marie Brière & Ombretta Signori, 2011. "Inflation hedging portfolios in different regimes," BIS Papers chapters,in: Bank for International Settlements (ed.), Portfolio and risk management for central banks and sovereign wealth funds, volume 58, pages 139-163 Bank for International Settlements.
    2. 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.
    3. Brière, Marie & Szafarz, Ariane, 2015. "Does Commercial Microfinance Belong to the Financial Sector? Lessons from the Stock Market," World Development, Elsevier, vol. 67(C), pages 110-125.
    4. 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.
    5. Aglietta, Michel & Brière, Marie & Rigot, Sandra & Signori, Ombretta, 2012. "Rehabilitating the role of active management for pension funds," Journal of Banking & Finance, Elsevier, vol. 36(9), pages 2565-2574.
    6. John Y. Campbell & Robert J. Shiller & Luis M. Viceira, 2009. "Understanding Inflation-Indexed Bond Markets," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(1 (Spring), pages 79-138.
    7. Marie Brière & Ombretta Signori, 2012. "Inflation-Hedging Portfolios : Economic Regimes Matter," Post-Print hal-01494498, HAL.
    8. repec:eee:empfin:v:48:y:2018:i:c:p:374-389 is not listed on IDEAS
    9. repec:dau:papers:123456789/14039 is not listed on IDEAS
    10. repec:dau:papers:123456789/7858 is not listed on IDEAS
    11. repec:dau:papers:123456789/9296 is not listed on IDEAS
    12. Marie Briere & Ariane Szafarz, 2011. "Investment in Microfinance Equity: Risk, Return, and Diversification Benefits," Working Papers CEB 11-050, ULB -- Universite Libre de Bruxelles.
    13. repec:dau:papers:123456789/7744 is not listed on IDEAS
    14. Covarrubias, Enrique & Hernández-del-Valle, Gerardo, 2016. "Inflation expectations derived from a portfolio model," MPRA Paper 69489, University Library of Munich, Germany.
    15. repec:eee:ecmode:v:67:y:2017:i:c:p:228-247 is not listed on IDEAS
    16. Geert Bekaert & Xiaozheng Wang, 2010. "Inflation risk and the inflation risk premium," Economic Policy, CEPR;CES;MSH, vol. 25, pages 755-806, October.

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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