An Empirical Analysis of the Benefits of Inflation- Linked Bonds, Real Estate and Commodities for Long-Term Investors with Inflation- Linked Liabilities

This paper proposes an empirical analysis of the welfare gains involved in introducing various assets with inflation-hedging properties for long-term investors facing inflationlinked liabilities. Using formal intertemporal spanning tests, we find that interest rate risk dominates inflation risk so dramatically within instantaneous liability risk that introducing inflation-linked bonds, commodities or real estate within the liability-hedging portfolio has relatively little impact on investors’ welfare from a short-term perspective. This holds true in spite of the relatively good (in the case of real assets) and even perfect (in the case of inflation-linked bonds) inflation-hedging benefits of these asset classes. On the other hand, substantial welfare gains are obtained as the investment horizon converges towards the liability maturity date. Even more substantial utility gains are obtained if these asset classes are also used in the performance-seeking portfolio, where they provide diversification benefits with respect to bond and equity returns.
JEL Classification: G11, G23
Keywords: inflation, liability-hedging portfolio, performance-seeking portfolio, real assets, utility gains.