Inflation, Money Demand and Portfolio Choice

We estimate a nominal life-cycle portfolio choice model using shopping costs to generate money demand. The model delivers realistic implications for stock market participation and portfolio composition because money crowds out other assets at lower levels of financial wealth. Higher mean inflation leads to a reallocation between money and bonds with a modest impact on stock holdings, while inflation risk can give rise to significant hedging demands. The impact of inflation volatility depends on whether stocks are a hedge against inflation risk. Higher inflation volatility reduces (increases) stock-holdings when inflation has a negative (positive) correlation with real stock returns