Optimal Portfolio Choice in Real Terms: Measuring the Benefits of TIPS

Journal of Empirical Finance, Volume 19, Issue 5, December 2012, Pages 721–740

34 Pages Posted: 12 Feb 2011 Last revised: 11 Mar 2013

See all articles by Álvaro Cartea

Álvaro Cartea

University of Oxford; University of Oxford - Oxford-Man Institute of Quantitative Finance

Jonatan Saúl

Universidad Carlos III de Madrid

Juan Toro

Fundación Instituto de Empresa, S.L. - IE Business School

Date Written: January 1, 2011

Abstract

In this paper, we solve an optimal portfolio choice problem to measure the bene fits of Treasury Inflation Indexed Securities (TIPS) to investors concerned with maximizing real wealth. We show how the introduction of a real riskless asset completes the investor asset space, by contrasting optimal portfolio allocations with and without such assets. We use historical data to quantify gains from availability of TIPS in the presence of other asset classes such as equities, commodities, and real estate. We draw a distinction between buy-and-hold long-term investors for whom TIPS fully displace nominal riskfree assets and short-term investors for whom TIPS improve the investment opportunity set of real returns. Finally, we show how gains from TIPS are tempered by availability of alternative assets that covary with inflation, such as gold and real estate.

Keywords: Portfolio Choice in Real Terms, Treasury Inflation Indexed Securities (TIPS), Buy-and-hold Long-term Investors, Money Illusion

JEL Classification: G11

Suggested Citation

Cartea, Álvaro and Saúl, Jonatan and Toro, Juan, Optimal Portfolio Choice in Real Terms: Measuring the Benefits of TIPS (January 1, 2011). Journal of Empirical Finance, Volume 19, Issue 5, December 2012, Pages 721–740. Available at SSRN: https://ssrn.com/abstract=1759188 or http://dx.doi.org/10.2139/ssrn.1759188

Álvaro Cartea (Contact Author)

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

Jonatan Saúl

Universidad Carlos III de Madrid ( email )

CL. de Madrid 126
Madrid, Madrid 28903
Spain

Juan Toro

Fundación Instituto de Empresa, S.L. - IE Business School ( email )

Calle Maria de Molina 12, Bajo
Madrid, Madrid 28006
Spain

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