The Inflation-Hedging Characteristics of Real and Financial Assets in Hong Kong

Executive Summary. This study examines whether real and financial assets in Hong Kong can hedge against inflation. Many studies have been undertaken using one or all of the three common ways of measuring inflation hedges: (1) comparison between inflation rates and rates of returns, (2) the Fama and Schwert Framework, and (3) co-integration techniques. The first method is considered inadequate due to the lack of any indication of the underlying process. Fama and Schwert proposed a methodology to measure an asset's inflation hedge against expected and unexpected inflation. Their method was adopted in many similar studies that followed. However, this methodology was criticised for being based on a static regression method, which was unable to differentiate between long-run equilibrium adjustments and short-run dynamic movement. Especially for real assets, a method of separating the long-run movements from any short-run ones is necessary. Therefore, many studies have employed co-integration techniques to test for the existence of any long-run equilibrium relationship between inflation and asset returns. In order to compare the inflation-hedging characteristics of both real and financial assets in Hong Kong during an eleven-year period (from 1984-94), the quarterly data was subjected to analysis using both the Fama and Schwert framework and co-integration techniques. The study concludes that real assets in general are not a good hedge against inflation, in the sense the methodologies imply. Further, financial assets in Hong Kong appear to have been a better hedge against inflation than real assets.