An assessment of the relative importance of real interest rates, inflation and term premia in determining the prices of real and nominal UK bonds
AbstractThis paper uses a dynamic accounting identity developed by Campbell to decompose movements in bond prices into elements due to changes in real interest rates, expected term premia and expected inflation. This decomposition is applied to UK short and long-maturity nominal bonds and index-linked bonds using data between 1983 and 1993. The main findings are that changes in expected inflation are by far the most important determinant of bond price movements. So much so that even for index-linked bonds changes in expected inflation (which have an effect due to the eight month indexation lag) are a more important factor than changes in real interest rates (which contribute less than 3% to the variance of index-linked bond prices). The paper also finds that changes in expected term premia are an important determinant of changes in both nominal and index-linked bond prices. However, the term premia appears to be a common factor which has little influence on the relative price of the two types of bond (ie break-even inflation rates). This suggests that changes in the relative price of the two type of bonds offer a reliable measure of changes in market expectations of inflation with about 95% of the variance of relative yields being due to revisions to expected inflation.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Bank of England in its series Bank of England working papers with number 32.
Date of creation: Apr 1995
Date of revision:
Contact details of provider:
Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH
Phone: +44 (0)171 601 4030
Fax: +44 (0)171 601 5196
Web page: http://www.bankofengland.co.uk/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Quah, Danny & Vahey, Shaun P, 1995.
"Measuring Core Inflation?,"
Economic Journal, Royal Economic Society,
Royal Economic Society, vol. 105(432), pages 1130-44, September.
- Tom Doan, . "RATS programs to replicate Quah and Vahey core inflation estimation," Statistical Software Components RTZ00139, Boston College Department of Economics.
- Danny Quah & Danny Quah & Shaun P. Vahey, 1995. "Measuring Core Inflation," CEP Discussion Papers dp0254, Centre for Economic Performance, LSE.
- Danny Quah & Shaun Vahey, 1995. "Measuring Core Inflation," Bank of England working papers, Bank of England 31, Bank of England.
- Quah, Danny, 1995. "Measuring Core Inflation," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1153, C.E.P.R. Discussion Papers.
- Campbell, John, 1987.
"Stock Returns and the Term Structure,"
3207699, Harvard University Department of Economics.
- Mishkin, Frederic S., 1992.
"Is the Fisher effect for real? : A reexamination of the relationship between inflation and interest rates,"
Journal of Monetary Economics, Elsevier,
Elsevier, vol. 30(2), pages 195-215, November.
- Frederic S. Mishkin, 1991. "Is the Fisher Effect for Real? A Reexamination of the Relationship Between Inflation and Interest Rates," NBER Working Papers 3632, National Bureau of Economic Research, Inc.
- Martin D. D. Evans, 2003.
"Real risk, inflation risk, and the term structure,"
Economic Journal, Royal Economic Society,
Royal Economic Society, vol. 113(487), pages 345-389, 04.
- Martin Evans, 2002. "Real Risk, Inflation Risk, and the Term Structure," Working Papers, Georgetown University, Department of Economics gueconwpa~02-02-10, Georgetown University, Department of Economics.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Publications Team).
If references are entirely missing, you can add them using this form.