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Inflation and Real Interest Rates on Assets with Different Risk Characteristics

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  • John Huizinga
  • Frederic S. Mishkin

Abstract

Several recent studies find that ex ante real returns for short-term U.S. Treasury securities are negatively correlated both with inflation and with nominal interest rates. This paper examines whether these findings extend to the short-term holding return on publicly and privately issued securities of longer maturity, are robust with respect to the choice of price index, and are stable over time. Our results show that before 1979 a negative relationship of ex ante real returns with inflation and nominal interest rates does appear for the longer maturity assets. In fact, the relationship grows stronger with increases in maturity length. This suggests that although short-term U.S. Treasury bills were, of all the assets we study, the best hedge against expected inflation, none of the assets were a perfect hedge. We find a statistically significant change in the stochastic process of bond returns in 1979, with nominal interest rates and ex ante real holding returns being positively correlated in this latter period. This is not true for stocks, however. While the above results are robust to the choice of price index, we show that estimating the level of ex ante real returns depends crucially on the price index chosen.

Suggested Citation

  • John Huizinga & Frederic S. Mishkin, 1984. "Inflation and Real Interest Rates on Assets with Different Risk Characteristics," NBER Working Papers 1333, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:1333
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    1. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
    2. Frederic S. Mishkin, 1983. "Are Market Forecasts Rational?," NBER Chapters,in: A Rational Expectations Approach to Macroeconomics: Testing Policy Ineffectiveness and Efficient-Markets Models, pages 59-75 National Bureau of Economic Research, Inc.
    3. Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, vol. 65(3), pages 269-282, June.
    4. Fama, Eugene F. & Schwert, G. William, 1977. "Asset returns and inflation," Journal of Financial Economics, Elsevier, vol. 5(2), pages 115-146, November.
    5. Lawrence H. Summers, 1982. "The Nonadjustment of Nominal Interest Rates: A Study of the Fisher Effect," NBER Working Papers 0836, National Bureau of Economic Research, Inc.
    6. Barro, Robert J., 1981. "Intertemporal substitution and the business cycle," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 14(1), pages 237-268, January.
    7. Cumby, Robert E. & Huizinga, John & Obstfeld, Maurice, 1983. "Two-step two-stage least squares estimation in models with rational expectations," Journal of Econometrics, Elsevier, vol. 21(3), pages 333-355, April.
    8. Alan S. Blinder, 1980. "The Consumer Price Index and the Measurement of Recent Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(2), pages 539-573.
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