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Abstract
Recent increases in inflation uncertainty have increased investor awareness of the need to hedge against unexpected changes in price levels. Given that the capacity of the inflation-linked securities market is not sufficient to meet the collective demand of institutional and private investors and that the OTC inflation derivatives market suffers from a perceived increase in counterparty risk, investors are now turning to other asset classes to seek inflation protection. Using a vector error correction model that explicitly distinguishes between short-term and long-term dynamics in the joint distribution of asset returns and inflation, the authors show that real estate and commodities have particularly attractive inflation-hedging properties over long horizons and that these properties justify the introduction of these asset classes into pension fund liability-hedging portfolios. These results suggest that novel forms of liability-driven investment solutions, including commodities and real estate in addition to inflation-linked securities, can be designed to decrease the cost of inflation insurance for long-horizon investors.
TOPICS: Pension funds, commodities, VAR and use of alternative risk measures of trading risk
- © 2009 Institutional Investor, Inc.
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