Investing - Theory, News & General • why isn't there in index and/or fund for both TIPS & conventional bonds?

Is there some shortcut or simplification that leads to 50-50 allocation that I'm missing?

I'll take a stab at answering, if the probability of inflation exceeding expectations is greater (or less) than 50%, bond buyers should favor the bond type with the >50% probability of getting better returns, thereby driving the price of that bond type up (and its yield down) until the probabilities are equalized at 50%. Otherwise there's a free lunch to be had, assuming the other risks in TIPS and conventional treasury bonds are roughly equal.

Thanks. A couple of issues that stick out.

First, a 50-50 dollar allocation is not the same as equalizing the probabilities of one winning over the other.

Second, the quoted argument says that the yield for one goes up (and the other goes down) as the demand adjusts to achieve some kind of 50-50 condition. But that would contradict the initial assumption that the difference between yield of nominal vs TIPS equals expected inflation. For their difference to be equal to expected inflation, both yields would always have to move in the same direction.

Here's a simple scenario. Suppose there are three possible inflation rate outcomes: 1%, 2%, or 6% each with probability 1/3. Then expected inflation is 3%. And there's a 2/3 chance inflation is less than expected. Note that this chance is not 50-50 regardless of how TIPS vs nominals are priced or allocated.

Now let's say real yield is 1%. Then nominal yield at market equilibrium is 4% to satisfy the breakeven rate assumption (i.e., that their difference is 3% expected inflation).

Then it turns out that every allocation between TIPS vs nominals has the same expected return of 4%. So the expected payoff becomes irrelevant to the choice of allocation. The allocation must depend entirely on other properties of the payoff distribution (e.g., variance). Which in turn depends on the distribution of inflation outcomes and, depending on how you model it, things like the investor's risk aversion and consumption pattern (e.g., nominal vs real). So for both individual investors and aggregated across all investors, a 50-50 allocation seems quite arbitrary without some further argument/assumptions about risk aversion and consumption patterns.

Statistics: Posted by djm2001 — Fri Nov 21, 2025 12:10 am — Replies 47 — Views 4276

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