Inflation Hedging: A Dynamic Approach Using Online Prices

Abstract

A vast literature, spanning back more than four decades, explores the relationship between inflation and asset prices. Most studies focus on the inflation hedging properties of stocks, bonds, or commodities assuming they are held in a static, buy-and-hold portfolio. Few have examined the inflation hedging properties of actively managed strategies. In this paper, we use high-frequency inflation indices derived from millions of product prices scraped from the websites of multi-channel retailers in 21 countries. We first show that these series contain forward-looking information with respect to official government inflation releases, and find that online inflation indices can predict changes in the breakeven inflation spread between nominal and inflation-linked Treasury bond yields in the United States. We then test an investment strategy to exploit this market inefficiency by allocating dynamically between Treasury Inflation Protected Securities (TIPS) and nominal Treasury bonds. A dynamic strategy offers investors the potential to capture the price appreciation of nominal bonds when realized inflation is below market expectations and the price appreciation of TIPS when realized inflation is above market expectations.

Keywords: inflation, hedging, investing

JEL Classification: G10, G11