Getting to the Core: Inflation Risks Within and Across Asset Classes

74 Pages Posted: 17 Feb 2021 Last revised: 10 Mar 2021

See all articles by Xiang Fang

Xiang Fang

The University of Hong Kong

Yang Liu

The University of Hong Kong - Faculty of Business and Economics

Nikolai L. Roussanov

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Date Written: February 1, 2021

Abstract

Decomposing inflation into core and non-core components (e.g., energy) sheds new light on the nature of inflation risk and risk premia. While stocks have insignificant exposure to headline inflation in the U.S., their core inflation betas are negative and energy betas are positive. Conventional inflation hedges such as currencies and commodities only hedge against energy inflation risk but not the core. These hedging properties are reflected in the prices of inflation risks: only core inflation carries a negative risk premium and its magnitude is consistent both within and across asset classes, whereas the price of energy inflation risk is indistinguishable from zero. The relative contribution of core and energy inflation varies over time, which helps explain why the correlation between stock and bond returns appears to switch sign in the data. We develop a two-sector New Keynesian model to account for these facts.

Suggested Citation

Fang, Xiang and Liu, Yang and Roussanov, Nikolai L., Getting to the Core: Inflation Risks Within and Across Asset Classes (February 1, 2021). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper , Available at SSRN: https://ssrn.com/abstract=3787513 or http://dx.doi.org/10.2139/ssrn.3787513

Xiang Fang

The University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
China

Yang Liu

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Nikolai L. Roussanov (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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