| Abstract: | This paper examines the effect of the following commonly used methods of incorporating random inflation into discrete-time models of the demand for risky assets: 1) the use of a multivariate normal probability distribution for nominal asset returns and the random inflation rate, and 2) the approximation of real asset returns by the difference between nominal returns and the rate of inflation. The combination of these assumptions results in a deceptively simple version of the inflationary capital asset pricing model (CAPM). However, in an approximation-free version of this model the expected value of real wealth does not exist. While it is obvious that mean-variance analysis is not applicable in such models, we also find that the model does not satisfy Ohlson's weakened conditions for a quadratic approximation to the portfolio selection problem. Furthermore, this model is neither a member of the generalized Pareto-Levy nor log-stable class of portfolio models analyzed by Fama, Samuelson, Ohlson, and Struck. |
