Inflation-Protecting Asset Allocation: A Downside Risk Analysis ERES Conference, 5 th July 2013
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Inflation-Protecting Asset Allocation: A Downside Risk Analysis
ERES Conference, 5th July 2013
Tim Koniarski, Steffen Sebastian
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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 (dividend-
price 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.