Asset Allocation with Inflation-Protected Bonds

Posted: 13 Feb 2004  

S.P. Kothari

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Jay A. Shanken

Emory University - Goizueta Business School; National Bureau of Economic Research (NBER)

Abstract

In the study reported here, we set out to examine whether and how the availability of indexed bonds might affect investors' asset allocation decisions. We used historical yields on conventional U.S. T-bonds and an inflation-forecasting model to create a series of hypothetical indexed bond returns. We found that the real (inflation-adjusted) returns on indexed bonds are less volatile than the returns on otherwise similar conventional bonds. Moreover, the correlation with stock returns is much lower for the indexed bonds. An examination of asset allocation among stocks, indexed bonds, conventional Treasuries, and a riskless asset suggests that substantial weight should be given to indexed bonds in an efficient portfolio. These conclusions are generally supported by analysis of the history of actual returns on U.S. Treasury Inflation-Indexed Securities (commonly known as TIPS) for February 1997 through July 2003.

Keywords: Portfolio Management, asset allocation, Debt Investments, return or yield measures, Economics

JEL Classification: G11, G12

Suggested Citation

Kothari, S.P. and Shanken, Jay A., Asset Allocation with Inflation-Protected Bonds. Financial Analysts Journal, Vol. 60, No. 1, pp. 54-70, January/February 2004. Available at SSRN: https://ssrn.com/abstract=500006

S.P. Kothari (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

E52-325
Cambridge, MA 02142
United States
617-253-0994 (Phone)
617-253-0603 (Fax)

Jay A. Shanken

Emory University - Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States
404-727-4772 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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