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The Benefits of Sovereign, Municipal and Corporate Inflation-Linked Bonds in Long-Term Investment Decisions

This paper proposes an empirical analysis of the opportunity gains involved in investing in inflation-linked bonds for long-term investors facing inflation-linked liabilities. Using formal intertemporal spanning tests, it finds that substantial welfare gains are obtained, especially over long-horizons. Introducing inflation-linked bonds allows investors to improve investor welfare because of their hedging and performance benefits; hence investors may attain the same welfare (risk-return trade-off) with a lower initial investment when inflation-linked bonds are available compared to investing in stocks and nominal bonds only. Even more substantial utility gains are obtained in situations where the regulatory value for investors’ liabilities contains a credit risk adjustment.

Author(s) :

Romain Deguest, Lionel Martellini, Vincent Milhau

Summary :

This paper proposes an empirical analysis of the opportunity gains involved in investing in inflation-linked bonds for long-term investors facing inflation-linked liabilities. Using formal intertemporal spanning tests, it finds that substantial welfare gains are obtained, especially over long-horizons. Introducing inflation-linked bonds allows investors to improve investor welfare because of their hedging and performance benefits; hence investors may attain the same welfare (risk-return trade-off) with a lower initial investment when inflation-linked bonds are available compared to investing in stocks and nominal bonds only. Even more substantial utility gains are obtained in situations where the regulatory value for investors’ liabilities contains a credit risk adjustment.

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Type : EDHEC Publication
Date : 23/04/2013
Keywords :

ALM and Asset Management