The work in [29] also shows positive correlations between inflation and commodity futures, which increase with the holding period. Furthermore, using a vector autoregressive model and the measures Fisher coefficient, Pearson correlation, hedge ratio and hedging demand, [3] show that commodity futures have a significant ability to hedge against inflation during their investigated period of — in the U.
Additionally, they highlight commodity futures in the markets energy, industrial metals and live cattle as good inflation hedges. However, they point out that the hedging properties vary over time. This is an additional motivation to apply Markov-switching models to identify different regimes.
Using a vector error-correction model, [30], however, come to the interesting result that effective short-term hedges, such as commodities, may not work over longer periods. The work in [31] argues in the same direction by mentioning stability issues by estimating respective beta values over time and focus on TIPS.
Overall, commodities show a positive correlation to inflation and have the best inflation-hedge properties of all alternative assets.
However, concerning the time horizon, short term or long term, the statements in the literature about the inflation-hedging properties of commodities vary, with the majority pointing in favor of long-term horizons. Gold In the empirical analysis, we will investigate different asset classes in different inflation, as well as market regimes.
We decided to include gold as an individual asset class. They find that the overall results are mixed, and both hedging properties depend on the considered time period, the momentum, the investigated market, as well as market regimes and differ for short-term and long-term horizons.
The authors in [32] themselves apply a time-varying Markov-switching approach and conclude that gold is partially able to hedge against inflation in the long run and that the hedging-properties are regime dependent. Real Estate It is generally assumed that real estate is a first-class inflation hedge. Nevertheless, there are also academic voices doubting the inflation-hedging potential of real estate. The author in [28] shows in his analysis of real assets that real estate seems to be a hedge against inflation.
The work in [33] examines the inflation-hedging effectiveness of residential, farmland and business real estate. In the single-asset analysis, only residential real estate seems to be a reasonable inflation hedge.
On the other hand, different portfolios consisting of all three real estate sub-categories in combination with various other financial assets provide a satisfying performance compared to inflation.
Once again, [2] conclude that the term-structure properties of listed real estate are already captured by traditional asset classes, such as stocks and bonds. However, the latter perform better in the long-run.
The work in [25] confirms that investing in real estate has attractive inflation-hedging qualities for a long-term investor. In combination with commodities and inflation-linked securities, portfolios can be designed so as to decrease the cost of inflation insurance over the long horizon. The work in [6] argues that direct real estate appears to be the most attractive real-asset investment option for the pre-retirement phase.
It shows low volatility and still achieves relatively high growth rates. Using a regression analysis, [34] show that REITreal returns are negatively correlated with the unexpected component of inflation. Therefore, equity and mortgage REIT investments may not provide inflation protection during inflationary periods.
Scientific opinions whether real estate is a good inflation hedge diverge significantly. Beside many supporters of the thesis that real estate is a useful inflation hedge, such as [2,28] or [25,34] doubt this thesis. Data According to the previous studies stocks, bonds, commodities and real estate were chosen as different asset classes to set up a dynamic inflation-protected investment strategy.
We also included gold for its role as a safe haven, especially during crises periods. As we wanted to include the first oil crisis of in our empirical analysis, the number of available indices was limited for some asset classes. Treasury Bond Index TR. For all of these indices, we work with monthly log returns from August until September Therefore, we performed a back calculation of these three indices via a linear regression, e.
Markov-Switching Model The application of Markov-switching models for the analysis of econometric time series started with the work of [35]. Typically, a Markov-switching model can be understood as a stochastic model consisting of various random processes.
First, we assume the existence of a Markov chain, which is described by different states and transition probabilities between these states. Usually, a Markov chain cannot be observed directly, but rather indirectly via effects to a second, observable process.
The distribution of this second process thereby depends on the state of the Markov chain. The observable process is usually given in the form of an econometric indicator or a market index. The dynamics of the stock returns, as well as the inflation rate are described by Markov-switching models. As proposed in [12], we apply a three-state model for the stock returns and the inflation rate.
At any point in time t these probabilities only depend on the information up to time t. In doing so, they are able to distinguish between normal low volatility, positive expected return and turbulent high volatility market phases. The turbulent phase however covers volatile upward and downward movements. Therefore, they include a third state. This is achieved by a multi-step approach in which it is not available.
Accordingly the real estate index is calculated back based on a regression with the U. Risks , 4, 9 7 of 21 the turbulent periods are split into periods with positive and negative expected return by using a second Markov-switching model. Compared to a direct application of a three-state Markov-switching model, this approach has been shown to be more robust, especially w. The resulting filtered probabilities are computed on the basis of all of the information available up to time t.
Their final classification is illustrated in Figure 1. The characteristics of each regime are summarized in Table 1. Due to the additional distinction within the turbulent periods, turbulent bullish and turbulent bearish phases can be separated. Referring to Figure 1, after a market downturn in a high volatile environment with mainly negative returns, often, some kind of recovery takes place, i. Focusing on skewness and kurtosis, we observe that the calm period has a slightly negative skewness and the turbulent period a stronger negative skewness, which is due to the turbulent negative period.
The turbulent positive period has a positive skewness. Reflecting the kurtosis, the relatively high kurtosis of the turbulent period is reduced by distinguishing in a positive and a negative turbulent state. Although from a return and standard deviation perspective, the calm and turbulent positive periods may look rather similar, both phases have rather different skewness and kurtosis, which supports the introduction of three market periods in the further analysis.
Figure 1. The approach of [12] detects a calm state green , a turbulent state with mainly negative returns bearish, red and a turbulent state with mainly positive returns bullish, yellow. Risks , 4, 9 8 of 21 Table 1. Here, a three-state model covers the three main regimes concerning the inflation rate: one state for low inflation State 1 , one state for high inflation State 3 and a transition state State 2.
Table 2, as well as Figure 2 illustrate the calibrated Markov-switching model for the inflation rate. We clearly observe that in low State 1 and high inflation State 3 regimes, the skewness is negative, whereas in the transition state State 2 , the skewness is positive. With respect to the kurtosis, we observe that the kurtosis is significantly decreasing from State 1—State 3. Table 2. Sample characteristics of the monthly inflation rate in the three states derived from the one three-state Markov-switching model.
Classification of the inflation regimes based on a Markov-switching model with three states. We detect a calm inflation state green , a high inflation state red and a transition inflation state yellow.
Risks , 4, 9 9 of 21 Regarding the classification of the inflation rate, the first oil crisis — , as well as the second oil crisis around are identified as periods in which inflation has been very high State 3. Additionally, the First Gulf War , as well as Hurricane Katrina and a short period within the financial crisis are also characterized as State 3. On the other side, the period starting in during the Savings-and-Loan crisis is rather supposed to be part of State 2, i.
The late s, as well as the early s are lastly an example for a period that has been dominated by a low inflation environment. Although, we observe some short peaks in the high inflation regime lately. In the following, we combine both classification results to separate the dataset into nine different regimes according to the states of the inflation indicator and the market indicator.
For the ease of exposition, we first sort the nine regimes by the state of the market indicator and then by the state of the inflation. Clearly, we observe a clustering of regimes with a calm market state, and it is shown that extreme regimes with a critical inflation and market state occur less frequently, but are still not unlikely. Figure 3. Overview of the separation into 9 regimes over the investigated period. Table 3 summarizes the regime changes over one time step, i. It is seen that most likely, there will be no regime change.
To be more specific, between two months, mainly one regime either the market state or the inflation state has changed if there is a regime change at all. More interestingly, by focusing on the inflation state, there most likely have only been switches from the low inflation to the inflation transition state and from the high inflation state to the inflation transition state.
This strengthens the three-regime approach for the inflation rate and also gives an economical interpretation of State 2 to be a transition state.
Table 3. Summary of regime changes. By focusing on the return perspective and by additionally considering the market state, we see that there is not a single asset class with an average return that is always higher than the average inflation rate. Hence, there is based on monthly data no asset class that can permanently be used as a hedge against inflation. Table 4. Not only do the correlations vary significantly, but also the signs of the correlations change between different regimes. Again, commodities are the only asset class that has a positive correlation in every single regime.
However, with increasing inflation and a normal or turbulent-bearish market state, the correlation between commodities and inflation decreases. For stocks, the correlation with inflation behaves similarly in normal and turbulent-bearish markets. If the market is turbulent-bullish, however, we observe a different picture. For low inflation, the correlation of stocks and inflation is low; if the inflation is in transition, the correlation occurs as more strongly negative; whereas in a high inflation state, the correlation occurs as more strongly positive.
Real estate has moderate negative correlation with inflation, except in the case of inflation in transition and a turbulent-bearish market; there, the correlation is moderately positive.
Gold has a positive correlation with inflation, except in cases when the inflation is in transition and the market is either calm or turbulent-bullish. Bonds show light positive and negative correlations with inflation.
However, if inflation is in transition and the market turbulent-bearish, the positive correlation increases, and if inflation is high and the market turbulent-bullish, the correlation with the inflation yields a higher negative value. This varying behavior in different regimes may be an explanation for the different findings about the correlation between specific asset classes and inflation in the literature as described in Section 2.
Table 6. As you can see in the chart below, gold prices were increasing in the 70s, when the inflation rate was high and accelerating, while they were decreasing in the 80s and the 90s, when the inflation rate was declining. Chart 2: Gold prices yellow line, left axis and inflation rates red line and right axis from to Summing up, gold is often seen as an inflation hedge. However, the data challenges this opinion, at least regarding the short run which, however, may last longer than the name itself would suggest.
That view stems almost entirely from the very fact that gold used to be money, which could not be printed, and due to the experience of the inflationary 70s, when the monetary system changed and the price of gold floated freely. However, we live now in a completely different monetary system, which essentially explains why gold is a rather poor short-term inflation hedge. Given the opportunity costs, investors should expect only significant and lasting inflation to drive the price of gold up.
In other words, gold may serve as an inflation hedge only when there is relatively high inflation, usually accompanied by fears about the current state of the U. We encourage you to learn more about gold — not only how it is affected by inflation, but also how to successfully use the shiny metal as an investment and how to profitably trade it.
A great way to start is to sign up for our gold newsletter today. It's free and if you don't like it, you can easily unsubscribe. The World Gold Council found that between and , there were only eight years when U. In those years, gold prices jumped by an average of An April report from the World Gold Council notes that the benefits of certain portfolio hedges were underscored during the Great Recession, the European debt crisis, the pullback in the stock market, and the economic upheaval of The Economist points out that several experts, including researchers at Morgan Stanley and hedge fund manager Ray Dalio, predict a surge in inflation amid worries about the influx of stimulus funds pushing up prices.
Stock prices and inflation hedged firms. This article uses over 30 years of accounting … Expand. An evaluation of gold as an inflation hedge: Empirical evidence from South Africa. The plague of inflation eating into investor returns is one that is experienced universally by all investors. Gold has historically proven to provide good inflationary hedging ability, due to its … Expand. View 1 excerpt, cites background. Economics, Computer Science. Causal Inference in Econometrics.
Is Gold an Inflation-Hedge? This paper investigates the inflation hedging role of gold price after controlling for the prices of other investment assets. We use annual data on the U.
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