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Real Basis Risk and Long-Horizon Inflation Hedging

Author

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  • Chen, Damiaan
  • Beetsma, Roel
  • van Wijnbergen, Sweder

Abstract

Inflation-linked bonds (ILBs) are indexed to official consumer prices, but the inflation exposure of long-horizon investors may differ from that index. We study how this "real basis risk" shapes optimal allocations to nominal government bonds, ILBs, and equities for investors resident in Germany, the Netherlands, the United Kingdom, and the United States. We document substantial cross-country heterogeneity in hedge effectiveness and optimal portfolios and show that real basis risk and its covariance with inflation determine the substitution between nominal bonds and ILBs. The welfare benefits of access to each asset class differ markedly across countries. The results imply that inflation risk persists over long horizons, despite investments in ILBs.

Suggested Citation

  • Chen, Damiaan & Beetsma, Roel & van Wijnbergen, Sweder, 2026. "Real Basis Risk and Long-Horizon Inflation Hedging," CEPR Discussion Papers 22011, Centre for Economic Policy Research.
    • Handle: RePEc:cpr:ceprdp:22011
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    File URL: https://cepr.org/publications/DP22011
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    Keywords

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    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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