Money Illusion and TIPS Demand

116 Pages Posted: 7 May 2018 Last revised: 27 Mar 2019

See all articles by Abraham Lioui

Abraham Lioui

EDHEC Business School

Andrea Tarelli

Catholic University of Milan

Date Written: March 22, 2019

Abstract

The market demand for TIPS is rather small. This seems surprising, as we show that a rational agent, dynamically investing into multiple asset classes over a 30-year horizon, benefits by a 1.7% certainty equivalent gain per annum from having access to inflation-indexed bonds. However, if the investor suffers from money illusion, the perceived gain reduces to 0.6%. Furthermore, the ex-ante subjective benefits become totally negligible if the money-illusioned investor is less sophisticated and ignores time variations in risk premia. Money illusion causes significant portfolio shifts from inflation-indexed toward nominal bonds, with little effects on equity allocations. The UK-based evidence confirms the baseline findings obtained from U.S. data.

Keywords: Money Illusion, Term Structure of Interest Rates, Portfolio Choice

JEL Classification: E43, E52, G11, G12

Suggested Citation

Lioui, Abraham and Tarelli, Andrea, Money Illusion and TIPS Demand (March 22, 2019). Available at SSRN: https://ssrn.com/abstract=3166909 or http://dx.doi.org/10.2139/ssrn.3166909

Abraham Lioui

EDHEC Business School ( email )

France

Andrea Tarelli (Contact Author)

Catholic University of Milan ( email )

Largo Gemelli, 1
Milan, 20123
Italy

HOME PAGE: http://https://sites.google.com/view/andreatarelli

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