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On the Limits of Hedging Inflation Risk in Investment Portfolios

Author

Listed:
  • Damiaan Chen
  • Roel Beetsma
  • Sweder van Wijnbergen

Abstract

We explore to what extent real returns on investment portfolios can be hedged against inflation risk by using existing financial market instruments. We empirically find that inflation-linked bonds offer only limited protection against inflation risk, while nominal debt and stocks play at least comparable roles in this respect. These findings apply to both a static and a dynamic setting. To explain the empirical results, we develop a theoretical framework that incorporates real basis risk. The demonstrated limits of hedging inflation risk are of particular relevance for long-term investors, such as pension funds with participants concerned about the real value of their pension benefits.

Suggested Citation

  • Damiaan Chen & Roel Beetsma & Sweder van Wijnbergen, 2026. "On the Limits of Hedging Inflation Risk in Investment Portfolios," Working Papers 858, DNB.
    • Handle: RePEc:dnb:dnbwpp:858
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    References listed on IDEAS

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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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