Inflation and Real Interest Rates on Assets with Different Risk Characteristics

Working Paper: NBER ID: w1333

Authors: John Huizinga; Frederic S. Mishkin

Abstract: Several recent studies find that ex ante real returns for short-term U.S. Treasury securities are negatively correlated both with inflation and with nominal interest rates. This paper examines whether these findings extend to the short-term holding return on publicly and privately issued securities of longer maturity, are robust with respect to the choice of price index, and are stable over time. Our results show that before 1979 a negative relationship of ex ante real returns with inflation and nominal interest rates does appear for the longer maturity assets. In fact, the relationship grows stronger with increases in maturity length. This suggests that although short-term U.S. Treasury bills were, of all the assets we study, the best hedge against expected inflation, none of the assets were a perfect hedge. We find a statistically significant change in the stochastic process of bond returns in 1979, with nominal interest rates and ex ante real holding returns being positively correlated in this latter period. This is not true for stocks, however. While the above results are robust to the choice of price index, we show that estimating the level of ex ante real returns depends crucially on the price index chosen.

Keywords: Inflation; Real Interest Rates; Treasury Securities; Risk Characteristics

JEL Codes: E31; E43; G12

Causal Claims

Cause	Effect
ex ante real returns (G12)	inflation (E31)
ex ante real returns (G12)	nominal interest rates (E43)
inflation (E31)	ex ante real returns (G12)
nominal interest rates (E43)	ex ante real returns (G12)
ex ante real returns (G12)	maturity length (C41)
maturity length (C41)	ex ante real returns (G12)
post-1979 nominal interest rates (E43)	ex ante real returns (G12)
post-1979 ex ante real returns (G19)	nominal interest rates (E43)
common stocks (G12)	nominal interest rates (E43)