US inflation-indexed bonds in the long run: a hypothetical view

Abstract

This paper investigates the role of US inflation-indexed bonds in the portfolios of expected utility maximizing investors. As there does not exist sufficient return data, holding period returns on inflation-indexed bonds are generated using three different assumptions concerning the behaviour of real yields over time. These returns are then allowed to enter the available asset set of risk-averse investors. Using data covering the period, 1927–1996, the results show that inflation-indexed bonds would have formed a large part of the portfolios of such investors. The result holds for various levels of risk-aversion and for holding periods of one month, one year, and five years. However, when this investment in inflation-indexed bonds is subjected to a statistical test the results indicate that investor utility is insignificantly affected by the inflation-indexed bond investment. Finally, sensitivity analysis shows that an unrealistically high real yield of 2.5% is required for inflation-indexed bond investme...