Investing Under Inflation Risk

Abstract:     
Inflation, a quiet but growing concern, is complicated by its unpredictability in timing and severity. A survey of 110 years of inflation data suggests that Treasury Bills track inflation better than equities or bonds, and this result is robust across 19 countries. In most periods of high inflation in these countries, however, equities produced much higher, though more volatile, returns, but in some periods returns were much lower. Observation of periods of high inflation in the US and other countries suggests that while Treasury Bills track inflation best optimal hedging portfolio composition varies over time. In the more recent periods from 1980 to June 2012, however, evidence exists for inclusion of alternatives to Treasury Bills such as HML, SMB, and some “Stealth Fighters.” Furthermore, within the most recent period, evidence suggests that TIPs and trend-following dynamic strategies, as proxied by CISDM EW CTA, appear to help track inflation in the absence of Treasury Bills. Consideration of gold and real estate suggests that these asset classes, although popular, are unlikely to be good candidates to hedge against inflation. Our results suggest that inflation can be tracked, but methodologies that include dynamic weighting schemes should be employed since the relationship amongst inflation, assets and investment strategies is very complex.

Number of Pages in PDF File: 20

Keywords: inflation, bills, bonds, stocks, HML, SMB, Stealth Fighters

JEL Classification: G11, G12, G15, F21, E31

working papers series