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Inflation-hedging portfolios in Different Regimes

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  • Marie Briere
  • Ombretta Signori

Abstract

The unconventional monetary policies implemented in the wake of the subprime crisis and the recent increase in inflation volatility have revived the debate on medium to long-term resurgence of inflation. This paper presents the optimal strategic asset allocation of an investor seeking to hedge inflation risk in different macroeconomic regimes. Using a vector-autoregressive model (VAR) for the joint dynamics of asset returns, inflation and other state variables, we investigate in the context of a simulation that allows for serial and cross-sectional inter-temporal dependencies the relationship between asset returns and different economic variables, at different investment horizons. We then study the optimal portfolio choice for the investor seeking to attain a fixed target for real returns on his investment horizon, with a shortfall probability constraint. We show that the strategic asset allocation differs sharply across regimes. In a volatile macroeconomic environment, inflation-linked bonds, equities, commodities and real estate play all an essential role in hedging a portfolio against inflation. In a more stable economic environment (“Great Moderation”), nominal bonds play the most significant role, with equities and commodities. An ambitious investor in terms of required real return should have a larger weighting in risky assets, especially commodities. We show the optimal allocation for each investor, depending on his target real return and tolerated shortfall probability.

Suggested Citation

  • Marie Briere & Ombretta Signori, 2009. "Inflation-hedging portfolios in Different Regimes," Working Papers CEB 09-047.RS, ULB -- Universite Libre de Bruxelles.
  • Handle: RePEc:sol:wpaper:09-047
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    Cited by:

    1. repec:dau:papers:123456789/7847 is not listed on IDEAS
    2. Andrew Ang & Marie Brière & Ombretta Signori, 2012. "Inflation and Individual Equities," NBER Working Papers 17798, National Bureau of Economic Research, Inc.
    3. Fulli-Lemaire, Nicolas, 2012. "Allocating Commodities in Inflation Hedging Portfolios: A Core Driven Global Macro Strategy," MPRA Paper 42852, University Library of Munich, Germany, revised 15 Oct 2012.
    4. Fulli-Lemaire, Nicolas, 2013. "Alternative inflation hedging strategies for ALM," MPRA Paper 43755, University Library of Munich, Germany.
    5. Fulli-Lemaire, Nicolas, 2012. "A Dynamic Inflation Hedging Trading Strategy Using a CPPI," MPRA Paper 42851, University Library of Munich, Germany, revised 13 Nov 2012.

    More about this item

    Keywords

    inflation hedge; pension finance; shortfall risk; portfolio optimisation;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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