Stock Returns and Inflation Risk: Implications for Portfolio Selection

43 Pages Posted: 12 Nov 2010 Last revised: 26 Dec 2010

See all articles by Tomek Katzur

Tomek Katzur

University of Groningen - Faculty of Economics and Business

Laura Spierdijk

University of Twente - Department of Behavioural, Management and Social Sciences - Financial Engineering section

Date Written: November 30, 2010

Abstract

This paper focuses on the exposure of common stocks to inflation risk and assesses the impact of this exposure on portfolio choice. We show that the relation between real stock returns and inflation rates, as well as the parameter uncertainty involved with this relation, has substantial influence on optimal asset allocations. During the 1985 – 2010 period, inflation risk induces a typical long-term investor to allocate up to 40 percentage points less of his wealth to stocks, as compared to a benchmark investor who believes that stocks are not exposed to inflation risk. The benchmark investor generally overstates expected stock returns and/or understates return volatility, resulting in too high stock allocations.

Keywords: inflation hedging, Fisher hypothesis, asset allocation, parameter uncertainty

JEL Classification: G11, G14

Suggested Citation

Katzur, Tomek and Spierdijk, Laura, Stock Returns and Inflation Risk: Implications for Portfolio Selection (November 30, 2010). Netspar Discussion Paper No. 11/2010-051, Available at SSRN: https://ssrn.com/abstract=1708123 or http://dx.doi.org/10.2139/ssrn.1708123

Tomek Katzur

University of Groningen - Faculty of Economics and Business ( email )

Postbus 72
9700 AB Groningen
Netherlands

Laura Spierdijk (Contact Author)

University of Twente - Department of Behavioural, Management and Social Sciences - Financial Engineering section ( email )

Hallenweg 17
Enschede, 7522NH
Netherlands

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