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Inflation risks and inflation risk premia

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    Abstract

    This paper investigates the link between the perceived inflation risks in macroeconomic forecasts and the inflation risk premia embodied in financial instruments. We first provide some stylized facts about the term structure of inflation compensation, inflation expectations and inflation risk premia in the euro area bond market. Latent factor models like ours fit data well, but are often critisized for lacking economic interpretation. Using survey inflation risks, we show that perceived asymmetries in inflation risks help interpret the dynamics of long-term inflation risk premia, even after controlling for a large number of macro and financial factors. JEL Classification: G12, E31, E43.

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    File URL: http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1162.pdf
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    Bibliographic Info

    Paper provided by European Central Bank in its series Working Paper Series with number 1162.

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    Length: 50 pages
    Date of creation: Mar 2010
    Date of revision:
    Handle: RePEc:ecb:ecbwps:20101162

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    Related research

    Keywords: Affine term structure models; state-space modelling; inflation compensation; inflation risk premia; inflation risks.;

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    References

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    1. Gürkaynak, Refet S. & Levin, Andrew & Swanson, Eric T, 2006. "Does Inflation Targeting Anchor Long-Run Inflation Expectations? Evidence from Long-Term Bond Yields in the US, UK and Sweden," CEPR Discussion Papers 5808, C.E.P.R. Discussion Papers.
    2. Söderlind, Paul, 2000. "Inflation Forecast Uncertainty," CEPR Discussion Papers 2499, C.E.P.R. Discussion Papers.
    3. Hans Dewachter & Marco Lyrio, 2003. "Macro Factors and the Term Structure of Interest Rates," International Economics Working Papers Series ces0304, Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics.
    4. 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.
    5. Emanuel Mönch, 2005. "Forecasting the yield curve in a data-rich environment - a no-arbitrage factor-augmented VAR approach," Working Paper Series 544, European Central Bank.
    6. Geert Bekaert & Seonghoon Cho & Antonio Moreno, 2005. "New-Keynesian Macroeconomics and the Term Structure," NBER Working Papers 11340, National Bureau of Economic Research, Inc.
    7. Andrew Ang & Geert Bekaert & Min Wei, 2006. "Do macro variables, asset markets, or surveys forecast inflation better?," Finance and Economics Discussion Series 2006-15, Board of Governors of the Federal Reserve System (U.S.).
    8. Juan Angel Garcia & Adrian van Rixtel, 2007. "Inflation-linked bonds from a Central Bank perspective," Occasional Paper Series 62, European Central Bank.
    9. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
    10. Philippe Mueller & Mikhail Chernov, 2008. "The Term Structure of Inflation Expectations," 2008 Meeting Papers 346, Society for Economic Dynamics.
    11. 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.
    12. Tao Wu, 2001. "Macro factors and the affine term structure of interest rates," Working Papers in Applied Economic Theory 2002-06, Federal Reserve Bank of San Francisco.
    13. Chernozhukov, Victor & Hong, Han, 2003. "An MCMC approach to classical estimation," Journal of Econometrics, Elsevier, vol. 115(2), pages 293-346, August.
    14. Jacob Ejsing & Juan Angel García & Thomas Werner, 2007. "The term structure of euro area break-even inflation rates - the impact of seasonality," Working Paper Series 830, European Central Bank.
    15. Matteo Ciccarelli & Juan Angel García, 2009. "What drives euro area break-even inflation rates?," Working Paper Series 996, European Central Bank.
    16. Sharon Kozicki & P.A. Tinsley, 1997. "Shifting endpoints in the term structure of interest rates," Research Working Paper 97-08, Federal Reserve Bank of Kansas City.
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    Cited by:
    1. José Valentim Machado Vicente & Osmani Teixeira de Carvalho Guillen, 2010. "Do Inflation-linked Bonds Contain Information about Future Inflation?," Working Papers Series 214, Central Bank of Brazil, Research Department.
    2. Kajuth, Florian & Watzka, Sebastian, 2008. "Inflation expectations from index-linked bonds: Correcting for liquidity and inflation risk premia," Discussion Papers in Economics 4858, University of Munich, Department of Economics.
    3. Geert Bekaert & Xiaozheng Wang, 2010. "Inflation risk and the inflation risk premium," Economic Policy, CEPR & CES & MSH, vol. 25, pages 755-806, October.

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