The Inflation Hedging Characteristics of U.S. And U.K. Investments: A Multi-Factor Error Correction Approach

Abstract

Historic analysis of the inflation hedging properties of stocks has produced anomalous results, with stocks often appearing to offer a perverse hedge against inflation. This has been attributed to the impact of real and monetary shocks to the economy, which influence both inflation and asset returns. It has been argued that real estate should provide a better hedge: however, empirical results have been mixed. This paper explores the relationship between commercial real estate returns (from both private and public markets) and economic, fiscal and monetary factors and inflation for U.S. and U.K. markets. Comparative analysis of general equity and small capitalization stock returns in both markets is carried out. Inflation is divided into expected and unexpected components using a variety of estimation techniques. The analyses are undertaken using the error correction approach. In the long run, once real and monetary variables are included, asset returns are positively linked to anticipated inflation but not to inflation shocks. Adjustment processes are, however, gradual and not within period. Real estate returns, particularly private market returns, exhibit characteristics that differ from those of stocks.

Keywords: Investment Returns, Real Estate, Inflation Hedging, Error Correction Model

JEL Classification: G12, R33