1. Inflation-Protecting Asset Allocation: A Downside Risk Analysis ERES Conference, 5 th July 2013 Tim Koniarski, Steffen Sebastian

2. 2Inflation-Protecting Asset Allocation Motivation The study is motivated by two facts: (1)Previous studies only focus on correlations between asset returns and the inflation rate to investigate the inflation-protecting abilities of assets analysed. (2)In the asset allocation context the variance is used as risk measure to determine optimal inflation-protecting portfolios.

3. 3Inflation-Protecting Asset Allocation Contribution We analyse horizon-dependent inflation-hedging abilities of the assets (cash, bonds, stocks and direct commercial real estate) using lower partial moments and compare the results to VAR-implied correlations. Account for asymmetric returns by bootstrapping multi-period returns. Augmented by transaction costs. Determine optimal inflation-protecting asset allocations within 2 nd order LPM (CLPM) framework. Variation of target returns.

4. 4Inflation-Protecting Asset Allocation VAR approach VAR model includes asset returns and additional state variables (dividend- price ratio, term spread, cap rate and inflation) VAR-implied variance: Multi-period returns are bootstrapped according to Benkwitz et al. (2001).

5. 5Inflation-Protecting Asset Allocation Lower partial moments Downside risk measure: Lower partial moments (LPM) The LPM of order n is estimated by where is the target rate and is the return of asset i with T observations. Focus on LPM of order n = 0, the shortfall probability LPM of order n = 1, the expected shortfall LPM of order n = 2, semivariance

6. 6Inflation-Protecting Asset Allocation Co-lower partial moments Portfolio context: Taking into account co-movements between assets According to Estrada (2008), a co-lower partial moment between asset i and j is defined as The resulting symmetric semivariance matrix is used for the portfolio optimization problem.

7. 7Inflation-Protecting Asset Allocation Data set Quarterly US data from 1978:Q1 to 2010:Q4. Direct real estate returns are d esmoothed appraisal-based returns with the method proposed by Geltner (1993).

8. 8Inflation-Protecting Asset Allocation VAR parameter estimates

9. 9Inflation-Protecting Asset Allocation Correlations between asset returns and inflation

10. 10Inflation-Protecting Asset Allocation Inflation-protecting qualities of assets

11. 11Inflation-Protecting Asset Allocation Minimum semivariance portfolios, target 0%

12. 12Inflation-Protecting Asset Allocation Minimum semivariance portfolios, target 1+2%

13. 13Inflation-Protecting Asset Allocation Conclusion Considering correlations to investigate inflation-hedging potential of assets can imply false conclusions. Inflation-protecting abilities of assets change substantially over the investment horizon. Cash performs best in the short run, but worst in the long run. Real estate protects investors best against inflation for longer investment periods. These changes also affect optimal inflation-protecting asset allocations. Investors requiring a higher real return allocate more volatile assets on a medium and long-term basis.