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Investing in a real world with mean-reverting inflation

Author

Listed:
  • Berkelaar, A.B.
  • Kouwenberg, R.R.P.

Abstract

People are concerned about maintaining purchasing power in times of rising inflation. We formulate investment objectives in terms of real wealth, assuming investors derive utility from the number of goods they can buy with their monetary wealth. We derive closed-form solutions for the portfolio choice problem of constant relative risk averse investors, under the assumption that inflation rates are mean-reverting. We consider alternative specifications for the inflation compensation offered by the available assets, in order to study the effect on portfolio choice and welfare. Moreover, we study the added value of inflation-indexed bonds for the investor in our real framework.

Suggested Citation

  • Berkelaar, A.B. & Kouwenberg, R.R.P., 2003. "Investing in a real world with mean-reverting inflation," Econometric Institute Research Papers EI 9960/A, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
    • Handle: RePEc:ems:eureir:698
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    More about this item

    Keywords

    Inflation-protection; Intertemporal hedging demand; Optimal asset allocation; Predictability;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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