The Inflation-Commodities Cycle : A Regime-Switching Approach to Inflation Hedging

This thesis examines the nuanced and dynamic relationship between inflation and commodities through the Markov Switching Vector Error Correction Model (MS-VECM). The model offers an innovative way to account for possible structural changes, particularly relevant given the temporal dynamics of inflation and commodities. The research considers core and non-core inflation and their co-movement with commodity prices, emphasizing the importance of understanding expected and unexpected inflation in devising effective hedging strategies. The findings confirm the effectiveness of commodities as a short-term inflation hedge and underscore how their hedging potential can vary across different economic regimes. This knowledge could prompt investors to adjust their portfolios more flexibly and regime-awarely when managing inflation risk rather than relying solely on static asset allocation strategies