Inflation and the Role of Bonds in Investor Portfolios
This paper explores both theoretically and enirically the role of nominalbonds of various maturities in investor portfolios in the U.S. One of its principal goals is to determine whether an investor who is constrained to limithis investment in bonds to a single portfolio of money-fixed debt instruments will suffer a serious welfare loss. Our interest in this question stemsi n part from the observation that many employer-sponsored savings plans limit a participant's investment choices to two types, a common stock fund and a money-fixed bond fund of a particular maturity. A second goal is to study the desirability and feasibility of introducing a market for index bonds (i.e. an asset offering a riskless real rate of return) in the U.S. capital markets.The theoretical framework is Merton's (1971) continuous time model of consumption and portfolio choice. Our measure of the welfare gain or loss from a given change in the investor's opportunity set is the increment to current wealth needed to completely offset the effect of the change. A novel feature of our empirical approach is the method of deriving equilibrium risk premia on the various asset classes. We employ the variance-covariance matrix of real rates of return estimated from historical data in combination with "reasonable" assumptions about net asset supplies and the economy-wide average degree of risk aversion to derive numerical values for these risk premia. This procedure allows us to circumvent the formidable estimation problems associated with using historical means, which are negative during some subperiods.Our main results are: (i) There can be a substantial loss in welfare for participants in savings plans offering a choice of only two funds, a diversified stock fund and an intermediate-term bond fund. Most of this loss can be eliminated by introducing as a third option a money market fund.(2) The potential welfare gain from the introduction of private index bonds in the U.S.capital market is probably not large enough to justify the costs of innovation.The major reason for the small gain is that one month bills with their small variance of real returns are an effective substitute for index bonds.
|Date of creation:||Mar 1983|
|Publication status:||published as Bodie, Zvi, Alex Kane, Robert McDonald. "Inflation and the Role of Bonds in Investor Portfolios." Corporate Capital Structures in the United States, edited by Benjamin M. Friedman. Chicago UCP. (1985), pp. 167-194.|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, vol. 83(3), pages 509-534, June.
- Barro, Robert J., 1974.
"Are Government Bonds Net Wealth?,"
3451399, Harvard University Department of Economics.
- S. Grossman & R. Shiller, .
"The Determinants of the Variability of Stock Market Price,"
Rodney L. White Center for Financial Research Working Papers
18-80, Wharton School Rodney L. White Center for Financial Research.
- Grossman, Sanford J & Shiller, Robert J, 1981. "The Determinants of the Variability of Stock Market Prices," American Economic Review, American Economic Association, vol. 71(2), pages 222-227, May.
- Sanford J. Grossman & Robert J. Shiller, 1980. "The Determinants of the Variability of Stock Market Prices," NBER Working Papers 0564, National Bureau of Economic Research, Inc.
- Zvi Bodie, 1979. "Inflation Risk and Capital Market Equilibrium," NBER Working Papers 0373, National Bureau of Economic Research, Inc.
- Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, vol. 65(5), pages 900-922, December.
- Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
- Frederick R. Macaulay, 1938. "Some Theoretical Problems Suggested by the Movements of Interest Rates, Bond Yields and Stock Prices in the United States since 1856," NBER Books, National Bureau of Economic Research, Inc, number maca38-1, Enero.
- Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:1091. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.