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Inflation Expectations, Real Rates, and Risk Premia: Evidence from Inflation Swaps

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  • Joseph Haubrich
  • George Pennacchi
  • Peter Ritchken

Abstract

We develop a model of nominal and real bond yield curves that has four stochastic drivers but seven factors: three factors primarily determine the cross-section of yields, whereas four volatility factors solely determine risk premia. The model is estimated using nominal Treasury yields, survey inflation forecasts, and inflation swap rates and has attractive empirical properties. Time-varying volatility is particularly apparent in short-term real rates and expected inflation. Also, we detail the different economic forces that drive short- and long-term real and inflation risk premia and provide evidence that Treasury inflation-protected securities were undervalued prior to 2004 and during the recent financial crisis. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Studies in its journal Review of Financial Studies.

Volume (Year): 25 (2012)
Issue (Month): 5 ()
Pages: 1588-1629

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Handle: RePEc:oup:rfinst:v:25:y:2012:i:5:p:1588-1629

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Cited by:
  1. Matthias Fleckenstein & Francis A. Longstaff & Hanno Lustig, 2013. "Deflation Risk," NBER Working Papers 19238, National Bureau of Economic Research, Inc.
  2. Davis, Scott & Mack, Adrienne, 2013. "Cross-country variation in the anchoring of inflation expectations," Staff Papers, Federal Reserve Bank of Dallas, Federal Reserve Bank of Dallas, issue Oct.
  3. Jens H.E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2012. "Extracting Deflation Probability Forecasts from Treasury Yields," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 8(4), pages 21-60, December.
  4. Alan M. Rai, 2013. "The Impact of Policy Initiatives on Credit Spreads during the 2007-09 Financial Crisis," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 9(1), pages 45-104, March.
  5. Joseph Haslag & William Brock, 2014. "On Understanding the Cyclical Behavior of the Price Level and Inflation," Working Papers, Department of Economics, University of Missouri 1404, Department of Economics, University of Missouri, revised 01 Jul 2014.
  6. Kitsul, Yuriy & Wright, Jonathan H., 2013. "The economics of options-implied inflation probability density functions," Journal of Financial Economics, Elsevier, Elsevier, vol. 110(3), pages 696-711.
  7. Jens H. E. Christensen & James M. Gillan, 2013. "Does quantitative easing affect market liquidity?," Working Paper Series 2013-26, Federal Reserve Bank of San Francisco.
  8. Michael Abrahams & Tobias Adrian & Richard K. Crump & Emanuel Moench, 2012. "Pricing TIPS and treasuries with linear regressions," Staff Reports 570, Federal Reserve Bank of New York.
  9. Vadim Khramov, 2013. "Estimating Parameters of Short-Term Real Interest Rate Models," IMF Working Papers 13/212, International Monetary Fund.
  10. J. Scott Davis, 2012. "Central bank credibility and the persistence of inflation and inflation expectations," Globalization and Monetary Policy Institute Working Paper 117, Federal Reserve Bank of Dallas.
  11. Bauer, Michael D., 2014. "Inflation expectations and the news," Working Paper Series 2014-9, Federal Reserve Bank of San Francisco.
  12. Joseph W. Gruber & Robert J. Vigfusson, 2012. "Interest rates and the volatility and correlation of commodity prices," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 1065, Board of Governors of the Federal Reserve System (U.S.).
  13. Rodrigo Caputo & Luis Oscar Herrera, 2013. "Efficient CPI-Based Taylor Rules in Small Open Economies," Working Papers Central Bank of Chile, Central Bank of Chile 694, Central Bank of Chile.
  14. Michael J. Fleming & John R. Sporn, 2013. "Trading activity and price transparency in the inflation swap market," Economic Policy Review, Federal Reserve Bank of New York, Federal Reserve Bank of New York, issue May, pages 45-57.
  15. Olesya V. Grishchenko & Joel M. Vanden & Jianing Zhang, 2013. "The informational content of the embedded deflation option in TIPS," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2013-24, Board of Governors of the Federal Reserve System (U.S.).
  16. Marcello Pericoli, 2012. "Expected inflation and inflation risk premium in the euro area and in the United States," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 842, Bank of Italy, Economic Research and International Relations Area.
  17. Bruno Feunou & Jean-Sébastien Fontaine, 2012. "Forecasting Inflation and the Inflation Risk Premiums Using Nominal Yields," Working Papers, Bank of Canada 12-37, Bank of Canada.
  18. Marcello Pericoli, 2013. "Macroeconomic and monetary policy surprises and the term structure of interest rates," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 927, Bank of Italy, Economic Research and International Relations Area.
  19. Olesya V. Grishchenko & Joel M. Vanden & Jianing Zhang, 2011. "The information content of the embedded deflation pption in TIPS," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2011-58, Board of Governors of the Federal Reserve System (U.S.).
  20. Elmar Mertens, 2011. "Measuring the level and uncertainty of trend inflation," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2011-42, Board of Governors of the Federal Reserve System (U.S.).

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