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Time and place where gold acts as a hedge against inflation: An application of long run and short run threshold model. Wang, Lee and Thi (2011)

by on November 9, 2012

This 2012 paper provides an advanced analysis of whether gold acts as hedge against inflation risk in the US and Japan.

The authors test whether a long run mean reverting relationship exists between gold and inflation using cointegration techniques. They find that gold does hedge against inflation risk in the US but not in Japan. They also find that inflation causes changes in the price of gold in the US. The difference between the two countries is explained by price stickiness in Japan where adjustment is slow.

The major finding of the study is that golds ability to hedge is affected by the timing of the investment in gold. The “High momentum regime” refers to the adjustment momentum between prices. It is defined as a period where the change in the price of gold is greater than the change in long run CPI. In this regime gold acts as a good hedge against inflation in the US but is ineffective in Japan where the cross-price elasticity between gold and CPI is low. A low momentum regime occurs when the variation margin of the gold price is less than the rate of change of long-run CPI. The authors say that this means that the variation margin of the gold price must adjust upward, but when this is not the case gold fails to act as an inflation hedge.

Method: Unit root and cointegration tests. These incorporate models from the hreshold autoregression (TAR) family testing for cointegration and non-linear effects.

Data: Monthly average spot Gold price (London Fixing) in Yen and UD Dollars. Monthly CPI from IFS (IMF). 1971 – 2010.

Abstract: This study examines the short-run and long-run inflation hedging effectiveness of gold in the United States and Japan during the period of January 1971 to January 2010. Previous research has shown in the long-run that inflation tends to appropriately increase the price of gold in the U.S., leading to gold’s popularity as an asset in portfolios to reduce the risk against sudden inflation. However, gold is only partially effective in hedging against inflation in Japan. This research found that the rigidity between the price of gold and the consumer price index affects the inflation hedging ability of gold in the long-run. The gold price is characterized by market disequilibrium induced by the price rigidity, causing the price of gold to be unable to response to changes in the CPI. To explore the inflation hedging ability of gold in the short-run, this study further examines the price rigidity in low and high momentum regime. It is found during the low momentum regimes that, gold return is unable to hedge against inflation in either the U.S. or Japan. However, during high momentum regimes, gold return is able to hedge against inflation in the U.S., while the price rigidity in Japan causes the price of gold to not fully hedge against inflation in the short-run.

Full Citation: Wang, K.-M., Lee, Y.-M., & Thi, T.-B. N. (2011). Time and place where gold acts as an inflation hedge: An application of long-run and short-run threshold model. Economic Modelling, 28(3), 806–819

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From → Empirical, Gold

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