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Hedging inflation risk in a developing economy: The case of Brazil

Authors
Journal
Research in International Business and Finance
0275-5319
Publisher
Elsevier
Volume
27
Issue
1
Identifiers
DOI: 10.1016/j.ribaf.2012.04.003
Keywords
  • Inflation Hedge
  • Pension Finance
  • Shortfall Risk
  • Portfolio Optimisation

Abstract

Abstract Inflation shocks are one of the pitfalls of developing economies and are usually difficult to hedge. This paper examines the optimal strategic asset allocation for a Brazilian investor seeking to hedge inflation risk at different horizons, ranging from one to 30 years. Using a vector-autoregressive specification to model inter-temporal dependency across variables, we measure the inflation hedging properties of domestic and foreign investments and carry out a portfolio optimisation. Our results show that foreign currencies complement traditional assets very efficiently when hedging a portfolio against inflation: around 70% of the portfolio should be dedicated to domestic assets (equities, inflation-linked (IL) bonds and nominal bonds), whereas 30% should be invested in foreign currencies, especially the US dollar and the euro.

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