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Inflation and portfolio selection
This study proposes and tests a portfolio selection model with inflation allocation lines (IAL) for
corresponding capital allocation line (CAL) and utilities in several scenarios of crisis. The model is
based on Markowitz’s mean-variance (MV) theory, with modification of Tobin’s portfolio utility
function, and Sharpe’s (1964) portfolio theory. The model introduces inflation as a significant
factor. According to study results, empirically tested with least squares (OLS) and quantile
regression models, the study verifies that under conditions of low and moderate inflation the
investor chooses an optimal portfolio which generates the highest real returns (including borrowed
funds). For the case of severe recession, the investor chooses a minimum variance
portfolio.