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Inflation Expectations and Risk Premiums in an Arbitrage-Free Model of Nominal and Real Bond Yields

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  • JENS H. E. CHRISTENSEN
  • JOSE A. LOPEZ
  • GLENN D. RUDEBUSCH

Abstract

Differences between yields on comparable-maturity U.S. Treasury nominal and real debt, the so-called breakeven inflation (BEI) rates, are widely used indicators of inflation expectations. However, better measures of inflation expectations could be obtained by subtracting inflation risk premiums (IRP) from the BEI rates. We provide such decompositions using an affine arbitrage-free model of the term structure that captures the pricing of both nominal and real Treasury securities. Our empirical results suggest that long-term inflation expectations have been well anchored over the past few years, and IRP, although volatile, have been close to zero on average. Copyright (c) 2010 The Ohio State University No claim to original US government works.

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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 42 (2010)
Issue (Month): s1 (09)
Pages: 143-178

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Handle: RePEc:mcb:jmoncb:v:42:y:2010:i:s1:p:143-178

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October.
  2. Francis X. Diebold & Canlin Li, 2003. "Forecasting the Term Structure of Government Bond Yields," NBER Working Papers 10048, National Bureau of Economic Research, Inc.
  3. Hördahl, Peter & Tristani, Oreste, 2010. "Inflation risk premia in the US and the euro area," Working Paper Series 1270, European Central Bank.
  4. Jens H. E. Christensen & Francis X. Diebold & Glenn D. Rudebusch, 2007. "The Affine Arbitrage-Free Class of: Nelson-Siegel Term Structure Models," NBER Working Papers 13611, National Bureau of Economic Research, Inc.
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  9. Ang, Andrew & Bekaert, Geert, 2004. "The Term Structure of Real Rates and Expected Inflation," CEPR Discussion Papers 4518, C.E.P.R. Discussion Papers.
  10. Olesya V. Grishchenko & Jing-zhi Huang, 2012. "Inflation risk premium: evidence from the TIPS market," Finance and Economics Discussion Series 2012-06, Board of Governors of the Federal Reserve System (U.S.).
  11. Darrell Duffie & Rui Kan, 1996. "A Yield-Factor Model Of Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(4), pages 379-406.
  12. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
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