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Choosing Inflation Measures for Historical Asset Data

Article Quant Q&A · Author: poorly_built_human
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Summary

The discussion considers whether historical asset prices should be adjusted for inflation and which inflation series to use. It identifies the U.S. Consumer Price Index for All Urban Consumers as the commonly cited headline measure, distinguishing it from narrower indexes for categories such as housing, energy, and apparel. One answer points to this broad CPI as the usual default for realized inflation adjustments.

A second answer suggests that forward-looking inflation expectations may be more relevant when asset prices already reflect expected inflation. It names inflation swaps as one possible source, while cautioning that swap rates include an inflation risk premium. Cleveland Fed estimates are offered as an example that adjusts for this premium. The discussion does not establish that inflation adjustment is necessary for every analysis, compare the measures empirically, or specify a universal procedure; the appropriate choice depends on the research question and the kind of inflation effect being studied.

Key ideas

  • Broad U.S. consumer price inflation is commonly represented by the all-urban-consumer CPI.
  • Narrow CPI categories can be selected when a study concerns specific consumption costs.
  • Forward-looking inflation expectations may suit analyses where asset prices reflect expected inflation.
  • Inflation swap measures include a risk premium, which can affect their interpretation.
  • The discussion offers options but does not show when inflation adjustment is necessary.

Tags

StatisticsUS marketsBacktesting
Full text
# How To Account For Inflation Over Historical Data


# How To Account For Inflation Over Historical Data












I believe inflation is greatly affecting my sample data, even when using percent-changes for movements. I have read this post, which recommends the formula ((Current-Base Year CPI) * Price) / (Historical Year CPI) - and uses the U.S Consumer Price Index For All Urban Consumers. However, there are many of these indexes (Apparel, Energy, Housing, etc.).

What is the standard practice for quants, and is this even necessary? (I see no other questions on this stack, and this post earned me a tubmleweed).

## Answer by User1996 (score 2, accepted)

https://quant.stackexchange.com/a/14010

The U.S. Consumer Price Index For All Urban Consumers (http://research.stlouisfed.org/fred2/series/CPIAUCSL) is the CPI you hear in the news, and is the standard inflation number.

## Answer by Helin (score 3)

https://quant.stackexchange.com/a/14011

There are actually a lot of options nowadays.

Adjusting your data using historical realized inflation is certainly one way to go. And as @User1996 mentioned, the CPI for All Urban Consumers is the frequently quoted "headline" number.

However, to the extent that asset prices reflect inflation expectations, it might be better to use forward-looking inflation expectations instead. For example, you could use inflation swaps (which are not perfect measure, since they embed an inflation risk premium). An excellent series that I frequently use in my own research is Cleveland Fed's inflation expectations estimates (http://www.clevelandfed.org/research/data/inflation_expectations/, there's an Excel spreadsheet at the bottom). These are also based on inflation swap, but subtracts out inflation risk premium.

I also publish some inflation expectations data on my blog http://hungrydummy.com/chart/.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.