Working Paper Series

Money Illusion: A Rationale for the TIPS Puzzle

Why is the TIPS market so small? We show that a rational agent, dynamically investing into multiple asset classes over a 20-year horizon, benefits by 1.2% per annum from having access to inflation- ...

Author(s) :

Andrea Tarelli

Abstract :

Why is the TIPS market so small? We show that a rational agent, dynamically investing into multiple asset classes over a 20-year horizon, benefits by 1.2% per annum from having access to inflation-indexed bonds. However, if the investor suffers from money illusion, the perceived certainty equivalent gains reduce to less than 0.3%. Furthermore, the benefits become totally negligible if the money-illusioned investor is less sophisticated and ignores time variations in risk premia. Money illusion causes significant portfolio shifts from inflation-indexed toward nominal bonds, with little effects on equity allocations.

Keywords: Money illusion, Term structure of interest rates, Portfolio choice.

Link SSRN

Working Paper - Money Illusion - Lioui, Tarelli...
(-1.00 B)
Date : 01/06/2018
Working Paper Number: WP-18-001

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