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. © 2022 Elsevier Inc.