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Dynamic hedging responses of gold and silver to inflation: A Markov regime-switching VAR analysis∗

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  • Valadkhani, Abbas
  • O'Mahony, Barry

Abstract

This study examines the impact of inflation on U.S. gold and silver returns using a Markov regime-switching vector autoregressive (VAR) model and threshold regression analysis with monthly data from January 1975 to October 2023. We account for the effect of annualized inflation rates on monthly transition probabilities between high and low inflation regimes, giving inflation a central role in influencing monthly returns for gold and silver. Our findings reveal distinct behaviors: gold returns show relatively sharp and sustained responses to inflation in high-inflation regimes, while these responses are subdued in low-inflation periods. This difference explains why some studies mistakenly conclude that gold's hedging effectiveness has declined, as they often overlook prolonged periods of high inflation. Gold remains an effective hedge in high-inflation environments, while silver complements it by offering protection in low-inflation periods. Silver's broader industrial uses make it more responsive to business cycles and output growth, rather than inflation alone. This study contributes to the literature by exploring the dynamics of response times, smoothness, and intensity across inflationary regimes, emphasizing the complementary roles of gold and silver in a diversified portfolio, particularly when inflation is expected to rise within the next five months.

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  • Valadkhani, Abbas & O'Mahony, Barry, 2024. "Dynamic hedging responses of gold and silver to inflation: A Markov regime-switching VAR analysis∗," International Review of Economics & Finance, Elsevier, vol. 96(PC).
    • Handle: RePEc:eee:reveco:v:96:y:2024:i:pc:s1059056024007330
    DOI: 10.1016/j.iref.2024.103741
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    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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