The authors are grateful to Michel Aglietta, Tobias Berg, Pascal Blanqué, Jean-François Boulier, Tony Bulger, Sylvie de Laguiche, Klaus Duellmann, Lionel Martellini, Marco Piersimoni, Gianni Pola, Ariane Szafarz, Natasha Todorovic, Marco Willner and an anonymous referee for helpful comments and suggestions. We thank Agence France Trésor for kindly providing data on Inflation Linked Bonds.
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Do Inflation-Linked Bonds Still Diversify?
Article first published online: 15 OCT 2008
DOI: 10.1111/j.1468-036X.2008.00470.x
© 2008 The Authors Journal compilation © 2008 Blackwell Publishing Ltd
Additional Information
How to Cite
Brière, M. and Signori, O. (2009), Do Inflation-Linked Bonds Still Diversify?. European Financial Management, 15: 279–297. doi: 10.1111/j.1468-036X.2008.00470.x
Publication History
- Issue published online: 2 MAR 2009
- Article first published online: 15 OCT 2008
- Abstract
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Keywords:
- inflation-linked bonds;
- optimal allocation;
- portfolio choice;
- conditional volatility;
- conditional correlation
- G11;
- G12
Abstract
The diversifying power of inflation-linked (IL) bonds relative to traditional asset classes has changed significantly. In this paper, we study the dynamics of conditional volatilities and correlations for three asset classes, IL bonds, nominal bonds and equities, in the USA and Europe. Using a DCC-MVGARCH for the period 1997–2007, we highlight the change that took place in 2003. Although IL bonds once had definite diversification power, they are now highly correlated with nominal bonds and have reached similar volatility levels. As a result, the two asset classes are practically substitutable. This seems to be due to more stable inflation expectations and to a more liquid IL bond market. Although diversification was a valuable reason for introducing IL bonds in a global portfolio before 2003, this is no longer the case. Dynamic portfolio optimisation using our estimates of conditional correlations and volatilities clearly demonstrates that the optimal weight of IL bonds in a portfolio decreased sharply in 2003 in favour of nominal bonds and equities.