What was the Market's View of UK Monetary Policy? Estimating Inflation Risk and Expected Inflation with Indexed Bonds
AbstractA measure of the credibility of monetary policy is the inflation risk premium embodied in nominal yields. This will be time varying and can be estimated by combining the information contained in the nominal term structure of interest rates with that in the real term structure of inflation-indexed bonds. Information can also be obtained about the real risk premium, and about expected inflation. We estimate these risk premia using a generalization of the Cox-Ingersoll-Ross (CIR) affine-yield model. We use a one-factor model of the real term structure based on monthly observations on two-year, five-year and ten-year UK index-linked debt, and a two-factor model of the nominal term structure for the corresponding nominal yields. Our estimates show that the inflation risk premium contributes on average about 100 basis points to nominal yields. Since the exit from the Exchange Rate Mechanism (ERM) this has fallen to about 70 basis points. This shows the greater credibility of monetary policy in recent years. The real risk premium is much higher, and has fluctuated between 170 and 260 basis points since exit from the ERM, reflecting uncertainty about the real economy. The inflation risk premium provides a correction to the break-even method of forecasting inflation and produces an unbiased forecast.
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 C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2022.
Date of creation: Nov 1998
Date of revision:
Contact details of provider:
Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820
Other versions of this item:
- Eli M. Remolona & Michael R. Wickens & Frank F. Gong, 1998. "What was the market's view of U.K. monetary policy? Estimating inflation risk and expected inflation with indexed bonds," Staff Reports 57, Federal Reserve Bank of New York.
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Smith, Peter N & Wickens, Michael R, 2002.
"Macroeconomic Sources of FOREX Risk,"
CEPR Discussion Papers
3148, C.E.P.R. Discussion Papers.
- 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.
- Joyce, Michael A.S. & Lildholdt, Peter & Sorensen, Steffen, 2010. "Extracting inflation expectations and inflation risk premia from the term structure: A joint model of the UK nominal and real yield curves," Journal of Banking & Finance, Elsevier, vol. 34(2), pages 281-294, February.
- Andrew Ang & Geert Bekaert & Min Wei, 2008.
"The Term Structure of Real Rates and Expected Inflation,"
Journal of Finance,
American Finance Association, vol. 63(2), pages 797-849, 04.
- Andrew Ang & Geert Bekaert, 2004. "The term structure of real rates and expected inflation," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
- Andrew Ang & Geert Bekaert & Min Wei, 2007. "The Term Structure of Real Rates and Expected Inflation," NBER Working Papers 12930, National Bureau of Economic Research, Inc.
- Ang, Andrew & Bekaert, Geert, 2004. "The Term Structure of Real Rates and Expected Inflation," CEPR Discussion Papers 4518, C.E.P.R. Discussion Papers.
- Smith, Peter & Wickens, Michael, 2002.
" Asset Pricing with Observable Stochastic Discount Factors,"
Journal of Economic Surveys,
Wiley Blackwell, vol. 16(3), pages 397-446, July.
- Peter N Smith & Michael R Wickens, . "Asset Pricing with Observable Stochastic Discount Factors," Discussion Papers 02/03, Department of Economics, University of York.
- Peter Hördahl & Oreste Tristani, 2012.
"Inflation Risk Premia In The Term Structure Of Interest Rates,"
Journal of the European Economic Association,
European Economic Association, vol. 10(3), pages 634-657, 05.
- Peter Hoerdahl & Oreste Tristani, 2007. "Inflation risk premia in the term structure of interest rates," BIS Working Papers 228, Bank for International Settlements.
- Hördahl, Peter & Tristani, Oreste, 2007. "Inflation risk premia in the term structure of interest rates," Working Paper Series 0734, European Central Bank.
- Juan Angel Garcia & Adrian van Rixtel, 2007.
"Inflation-linked bonds from a central bank perspective,"
Banco de Espaï¿½a Occasional Papers
0705, Banco de Espa�a.
- Juan Angel Garcia & Adrian van Rixtel, 2007. "Inflation-linked bonds from a Central Bank perspective," Occasional Paper Series 62, European Central Bank.
- Fung, Ben & Mitnick, Scott & Remolona, Eli, 1999. "Uncovering Inflation Expectations and Risk Premiums From Internationally Integrated Financial Markets," Working Papers 99-6, Bank of Canada.
- Madureira, Leonardo, 2007. "The ex ante real rate and inflation premium under a habit consumption model," Journal of Empirical Finance, Elsevier, vol. 14(3), pages 355-382, June.
- Martin Evans, 2002.
"Real Risk, Inflation Risk, and the Term Structure,"
gueconwpa~02-02-10, Georgetown University, Department of Economics.
- Peter Hördahl, 2008. "The inflation risk premium in the term structure of interest rates," BIS Quarterly Review, Bank for International Settlements, September.
- Barros Luís, Jorge & Cassola, Nuno, 2001. "A two-factor model of the German term structure of interest rates," Working Paper Series 0046, European Central Bank.
- Hans-Jürg Büttler, 2002. "The information content of the yield curve," BIS Papers chapters, in: Bank for International Settlements (ed.), Market functioning and central bank policy, volume 12, pages 298-328 Bank for International Settlements.
- Ben Siu Cheong Fung & Scott Mitnick & Eli M Remolona, 1999. "Inflation Expectations and Risks in a Two-Country Affine-Yield Model," CGFS Papers chapters, in: Bank for International Settlements (ed.), Market Liquidity: Research Findings and Selected Policy Implications, volume 11, pages 1-23 Bank for International Settlements.
- Nuno Cassola & Jorge Barros Luis, 2003. "A two-factor model of the German term structure of interest rates," Applied Financial Economics, Taylor & Francis Journals, vol. 13(11), pages 783-806.
- Martin Evans, 1998. "Looking Behind the U. K.Term Structure: Were there Peso Problems in Inflation?," Finance 9809001, EconWPA.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.