Inflation, Money Demand and Portfolio Choice *

Abstract

We estimate a structural, nominal, life-cycle portfolio choice model with exogenous housing tenure and use shopping costs to generate money demand. Homeowners (renters) with negative (positive) net bond positions react differently to changing inflation risks. The correlation between real bond and real stock returns emerges as the strongest inflation risk quantitatively and generates large increases in stock market demand for homeowners in a 1970s counterfactual. Higher expected inflation encourages stock market participation but affects negatively poorer households without access to that adjustment. A more negative inflation-bond return correlation pushes homeowners more into the stock market, while poorer renters move into money.

Keywords: JEL Classification: E41, G11, G50 Life-Cycle Models, Portfolio Choice, Inflation, Money Demand, Stock Market Participation, Hedging Demands

JEL Classification: E41, G11