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Do Inflation-linked Bonds Contain Information about Future Inflation?

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  • José Valentim Machado Vicente
  • Osmani Teixeira de Carvalho Guillen

Abstract

There is a widespread belief that inflation-linked bonds are a direct source of information about inflation expectations. In this paper we address this issue by analyzing the relationship between break-even inflation (the difference between nominal and real yields) and future inflation. The dataset is extracted from Brazilian Treasury bonds covering the period from April 2005 to July 2010. We find that break-even inflation is an unbiased forecast only of the 3-month and 6-month ahead inflation. For medium horizons (12 and 18 months) break-even inflation has weak explanatory power of future inflation. Over long horizons (24 and 30 months), we report a significant, but counterintuitive, negative relationship between the break-even and realized inflations.

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File URL: http://www.bcb.gov.br/pec/wps/ingl/wps214.pdf
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Bibliographic Info

Paper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 214.

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Date of creation: Oct 2010
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Handle: RePEc:bcb:wpaper:214

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Web page: http://www.bcb.gov.br/?english

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  1. Ruud, Paul A., 1984. "Tests of Specification in Econometrics," Department of Economics, Working Paper Series qt4kq8m0hf, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  2. Svensson, Lars E O, 1994. "Monetary Policy with Flexible Exchange Rates and Forward Interest Rates as Indicators," CEPR Discussion Papers 941, C.E.P.R. Discussion Papers.
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  5. García, Juan Angel & Werner, Thomas, 2010. "Inflation risks and inflation risk premia," Working Paper Series 1162, European Central Bank.
  6. Stefania D'Amico & Don H. Kim & Min Wei, 2010. "Tips from TIPS: the informational content of Treasury Inflation-Protected Security prices," Finance and Economics Discussion Series 2010-19, Board of Governors of the Federal Reserve System (U.S.).
  7. Shiller, Robert & Campbell, John, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Scholarly Articles 3221490, Harvard University Department of Economics.
  8. 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.).
  9. Joyce, Michael & Lildholdt, Peter & Sorensen, Steffen, 2009. "Extracting inflation expectations and inflation risk premia from the term structure: a joint model of the UK nominal and real yield curves," Bank of England working papers 360, Bank of England.
  10. Caio Ibsen R. Almeida & José Valentim M. Vicente, 2007. "Identifying Volatility Risk Premium from Fixed Income Asian Options," Working Papers Series 136, Central Bank of Brazil, Research Department.
  11. Peter Hördahl, 2008. "The inflation risk premium in the term structure of interest rates," BIS Quarterly Review, Bank for International Settlements, September.
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Cited by:
  1. Marçal, Emerson Fernandes & Valls Pereira, Pedro L., 2012. "Evaluating the existence of structural change in the brazilian term structure of interest : evidence based on cointegration models with structural break," Textos para discussão 314, Escola de Economia de São Paulo, Getulio Vargas Foundation (Brazil).
  2. Tabak, Benjamin M. & Takami, Marcelo & Rocha, Jadson M.C. & Cajueiro, Daniel O. & Souza, Sergio R.S., 2014. "Directed clustering coefficient as a measure of systemic risk in complex banking networks," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 394(C), pages 211-216.

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