Inflation-Protecting Asset Allocation: A Downside Risk Analysis
ERES Conference, 5th July 2013
Tim Koniarski, Steffen Sebastian
Motivation
The study is motivated by two facts:
(1) Previous studies only focus on correlations between asset returns and the
inflation rate to investigate the inflation-protecting abilities of assets
analysed.
(2) In the asset allocation context the variance is used as risk measure to
determine optimal inflation-protecting portfolios.
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Contribution
•
We analyse horizon-dependent inflation-hedging abilities of the assets
(cash, bonds, stocks and direct commercial real estate) using lower partial
moments and compare the results to VAR-implied correlations.
• Account for asymmetric returns by bootstrapping multi-period returns.
• Augmented by transaction costs.
•
Determine optimal inflation-protecting asset allocations within 2nd order
LPM (CLPM) framework.
• Variation of target returns.
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VAR approach
•
VAR model includes asset returns and additional state variables (dividendprice ratio, term spread, cap rate and inflation)
•
VAR-implied variance:
•
Multi-period returns are bootstrapped according to Benkwitz et al. (2001).
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Lower partial moments
•
Downside risk measure: Lower partial moments (LPM)
•
The LPM of order n is estimated by
where
•
is the target rate and
is the return of asset i with T observations.
Focus on
•
•
•
LPM of order n = 0, the shortfall probability
LPM of order n = 1, the expected shortfall
LPM of order n = 2, semivariance
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Co-lower partial moments
• Portfolio context: Taking into account co-movements between assets
•
According to Estrada (2008), a co-lower partial moment between asset i
and j is defined as
•
The resulting symmetric semivariance matrix is used for the portfolio
optimization problem.
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Data set
•
Quarterly US data from 1978:Q1 to 2010:Q4.
•
Direct real estate returns are desmoothed appraisal-based returns with the
method proposed by Geltner (1993).
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VAR parameter estimates
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Correlations between asset returns and
inflation
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Inflation-protecting qualities of assets
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Minimum semivariance portfolios, target 0%
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Minimum semivariance portfolios, target 1+2%
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Conclusion
•
Considering correlations to investigate inflation-hedging potential of assets
can imply false conclusions.
•
Inflation-protecting abilities of assets change substantially over the
investment horizon.
• Cash performs best in the short run, but worst in the long run.
• Real estate protects investors best against inflation for longer investment
periods.
•
These changes also affect optimal inflation-protecting asset allocations.
•
Investors requiring a higher real return allocate more volatile assets on a
medium and long-term basis.
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