The volatile inflationary environment in recent years has underscored the importance of inflation-hedging portfolio strategies, especially for developing markets. This study designed a regime-based asset allocation (RBAA) strategy for a portfolio of six asset classes (cash, equities, corporate bonds, government bonds, real estate, and commodities) that responds to inflation-regime switches in the Philippines. RBAA was implemented as a Markov decision process (MDP), with inflation regimes from a two-state Markov-switching auto-regression (MS-AR) with and time-varying transition probabilities (TVTP) model as the state space and a set of eight asset allocation strategies as the action space. Actions were selected based on a policy that maximises ending portfolio risk-adjusted excess return over inflation. The strategy successfully achieved inflation hedging with a risk-adjusted excess return of 0.54 over the period from April 2009 to June 2023, which was better than all eight static strategies. Further work is recommended to incorporate transaction costs and asset constraints to the MDP model. Findings from this study can be useful for investors who want to hedge inflation risk, and for regulators who can gain insights on the impact of inflation on the regime-dependent behaviour of asset classes in the Philippines.
@mastersthesis{osioThesis2023,author={Osio, Julber},school={University of London},title={Achieving inflation-hedging through regime-based asset allocation for Philippines-based investors},year={2023},bibtex_show=true}