Inflation Risk and Inflation Risk Premium

Transcription

1 Inflation Risk and Inflation Risk Premium by Geert Bekaert and Xiaozheng Wang Discussion by: Fabrizio Perri University of Minnesota and Minneapolis FED Economic Policy Meeting, Madrid, April 2010

2 The questions Do existing assets provide a good hedge against inflation risk? How big is the inflation risk premium i.e. the interest compensation markets demand for bearing inflation risk

3 The questions Do existing assets provide a good hedge against inflation risk? How big is the inflation risk premium i.e. the interest compensation markets demand for bearing inflation risk Relevant questions, in particular question 2 relevant now, i.e. can governments save substantial interest payments by issuing indexed bonds

4 Do existing assets provide good hedge against inflation risk? Methodology: i it = βπ it + ɛ it for different assets (stocks, bonds, real estate,gold, foreign bonds,portfolios), different countries, different time horizons (1 through 5 years) and different measures of inflation (total and unexpected)

5 Do existing assets provide good hedge against inflation risk? Methodology: i it = βπ it + ɛ it for different assets (stocks, bonds, real estate,gold, foreign bonds,portfolios), different countries, different time horizons (1 through 5 years) and different measures of inflation (total and unexpected) Bottom line: Most betas very far from 1, Next to impossible to use and individual asset or a portfolio of assets to adequately hedge inflation risk!

6 Is inflation hedging really that hard? Focus on US, stocks:

7 Is inflation hedging really that hard? Focus on US, stocks: YES 40 beta = (1.01) Stock Returns CPI Inflation

8 Is inflation hedging really that hard? Focus on US, 1 y. bonds:

9 Is inflation hedging really that hard? Focus on US, 1 y. bonds: NO Beta = 0.72 (.13) Bond Returns CPI Inflation

10 A summary One year nominal bonds in US possible hedge against 1 year inflation, but..

11 A summary One year nominal bonds in US possible hedge against 1 year inflation, but.. Still this does not mean that TIPS are not a useful instrument A sequence of short bonds hedge against inflation risk but subject to return risk Long bonds hedge return risk but subject to inflation risk

12 A summary One year nominal bonds in US possible hedge against 1 year inflation, but.. Still this does not mean that TIPS are not a useful instrument A sequence of short bonds hedge against inflation risk but subject to return risk Long bonds hedge return risk but subject to inflation risk TIPS hedge against both, provide certain real long return (complete intertemporal markets)

13 Source: Cambell, Shiller and Viceira, 2009 More direct evidence on the usefulness of real bonds US Inflation Indexed Bonds Outstanding % of Debt % of GDP Figure 1A UK Inflation Indexed Bonds Outstanding % of Debt % of GDP Figure 1B

14 How big is the inflation risk premium? How many real resources would governments save by issuing real instead of nominal bonds? And if a significant amount is it efficient for the government to do it (i.e. it is efficient for govt. to bear inflation risk)?

15 Exhibit 15: The answer Inflation Risk of the Premium paper Over Time Source: Ang, Bekaert and Wei (2008). The dark line represents the inflation risk premium lines a 90% confidence interval around the premium estimate. Inflation premium is volatile and HIGH, case for TIPS easy to make!

16 How is the inflation premium calculated? Compute a nominal pricing kernel (using nominal yield curve data) Compute a process for inflation and inflation expectation (using RE) Pick inflation risk premium at one maturity and let the model derive the premium at different maturities Key: do not use TIPS yields Identification not very intuitive, in particular why is the inflation risk premium high?

17 A CCAPM approach to inflation RP If CRRA utility, SDF = g γ c RP γcov(g c, π) Inflation risk premium is high if inflation is high at times of low consumption growth

18 10 years inflation and consumption growth years inflation and consumption growth y g_pce 10 y Infl

19 .008 CCAPM Risk premium (γ = 100) -RCINFGPCE10Y* Pattern of Inflation RP similar to ABW, level much lower

20 If Treasury liquidity premium is not too high (< 0.5%), Inflation risk premium is low or negative A more direct way of measuring inflation risk premium 6 Nominal yield and TIPS yield (10 CM) 3.0 Break even inflation (i - i tips) INOM10 ITIPS10 Inflation Expectations (Michigan) Inflation Risk Premium - Treasury Liq. premium

21 Conclusions Real bonds are useful in financial markets If inflation risk premium is high and if govts want to shoulder inflation risk, govts should use real bonds more

22 Conclusions Real bonds are useful in financial markets If inflation risk premium is high and if govts want to shoulder inflation risk, govts should use real bonds more Not clear that inflation risk premium is so high (might be negative)

23 Conclusions Real bonds are useful in financial markets If inflation risk premium is high and if govts want to shoulder inflation risk, govts should use real bonds more Not clear that inflation risk premium is so high (might be negative) Evidence points to higher inflation risk premium in the 1970s, yet real bonds have blossomed in the late 1990s. Maybe use of real bonds tied more to the explosion of derivatives or legal requirements.

24 Is (unexpected) inflation hedging really that hard? Focus on US, bonds:

25 Is (unexpected) inflation hedging really that hard? Focus on US, bonds: YES 16 Beta = 0.17 (0.26) Bond Returns Unexp. CP Inflation