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Real risk, inflation risk, and the term structure

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Martin D. D. Evans

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Abstract

I present a model for the term structures of nominal and real interest rates in the UK that incorporates Markov-switching and allows for non-neutralities, nonlinear dynamics, and flexibility in the dynamics of the risk premia. The model is used to assess how accurately the term structure reflects changing expectations of future yields and inflation. I find that variations in inflation expected over the next two to three years are very accurately reflected by current yields. Over longer horizons, the term structures closely track changing expectations regarding future nominal and real yields but not future inflation. Copyright 2003 Royal Economic Society.

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Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): 113 (2003)
Issue (Month): 487 (04)
Pages: 345-389
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Handle: RePEc:ecj:econjl:v:113:y:2003:i:487:p:345-389

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  1. Yong Zeng & Shu Wu, 2004. "A General Equilibrium Model of the Term Structure of Interest Rates under Regime-switching Risk," Econometric Society 2004 North American Summer Meetings 304, Econometric Society. [Downloadable!]
  2. Bikbov, Ruslan & Chernov, Mikhail, 2008. "Monetary Policy Regimes and the Term Structure of Interest Rates," CEPR Discussion Papers 7096, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  3. Peter S. Spiro, 2003. "Evidence on inflation expectations from Canadian real return bonds," Macroeconomics 0312004, EconWPA. [Downloadable!]
  4. Mauricio Larraín, 2007. "Inflation Compensation and Inflation Expectations in Chile," Working Papers Central Bank of Chile 421, Central Bank of Chile. [Downloadable!]
  5. Andrew Ang & Geert Bekaert, 2004. "The term structure of real rates and expected inflation," Proceedings, Federal Reserve Bank of San Francisco, issue Mar. [Downloadable!]
    Other versions:
  6. Peter Hördahl, 2008. "The inflation risk premium in the term structure of interest rates," BIS Quarterly Review, Bank for International Settlements, September. [Downloadable!]
  7. Tobias Adrian & Emanuel Moench, 2008. "Pricing the term structure with linear regressions," Staff Reports 340, Federal Reserve Bank of New York. [Downloadable!]
  8. Christiansen, Charlotte, 2002. "Regime Switching in the Yield Curve," Finance Working Papers 02-13, University of Aarhus, Aarhus School of Business, Department of Business Studies. [Downloadable!]
  9. Jardet, C. & Monfort, A. & Pegoraro, F., 2009. "No-arbitrage Near-Cointegrated VAR(p) Term Structure Models, Term Premia and GDP Growth," Documents de Travail 234, Banque de France. [Downloadable!]
  10. Stefania D'Amico & Don H. Kim & Min Wei, 2008. "Tips from TIPS: the informational content of Treasury Inflation-Protected Security prices," Finance and Economics Discussion Series 2008-30, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  11. Tobias Adrian & Hao Wu, 2009. "The term structure of inflation expectations," Staff Reports 362, Federal Reserve Bank of New York. [Downloadable!]
  12. Peter Hördahl & Oreste Tristani, 2007. "Mortage interest rate dispersion in the euro area," Working Paper Series 734, European Central Bank. [Downloadable!]
  13. João Libório, 2005. "Dynamic bond portfolio choice in a model with Gaussian diffusion regimes," European Journal of Finance, Taylor and Francis Journals, vol. 11(3), pages 259-270, June. [Downloadable!] (restricted)
  14. Peter Hordahl & Oreste Tristani & David Vestin, 2004. "A joint econometric model of macroeconomic and term structure dynamics," Money Macro and Finance (MMF) Research Group Conference 2003 48, Money Macro and Finance Research Group. [Downloadable!]
    Other versions:
  15. Peter Hördahl & Oreste Tristani & David Vestin, 2006. "The term structure of inflation risk premia and macroeconomic dynamics," Computing in Economics and Finance 2006 203, Society for Computational Economics. [Downloadable!]
  16. Hasseltoft, Henrik, 2007. "The Long-run Risk Model: Dynamics and Cyclicality of Interest Rates," SIFR Research Report Series 58, Institute for Financial Research. [Downloadable!]
  17. Monfort, A. & Pegoraro, F., 2007. "Switching VARMA Term Structure Models - Extended Version," Documents de Travail 191, Banque de France. [Downloadable!]
    Other versions:
  18. Hoi Wong & Tsz Wong, 2007. "Reduced-form Models with Regime Switching: An Empirical Analysis for Corporate Bonds," Asia-Pacific Financial Markets, Springer, vol. 14(3), pages 229-253, September. [Downloadable!] (restricted)
  19. Georges Dionne & Geneviève Gauthier & Khemais Hammami & Mathieu Maurice & Jean-Guy Simonato, 2007. "A Reduced Form Model of Default Spreads with Markov Switching Macroeconomic Factors," Cahiers de recherche 0741, CIRPEE. [Downloadable!]
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