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Term premiums and inflation uncertainty: empirical evidence from an international panel dataset

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  • Jonathan H. Wright

Abstract

This paper provides cross-country empirical evidence on term premia, inflation uncertainty, and their relationship. It has three components. First, I construct a panel of zero-coupon nominal government bond yields spanning ten countries and eighteen years. From these, I construct forward rates and decompose these into expected future short-term interest rates and term premiums, using both statistical methods (an affine term structure model) and using surveys. Second, I construct alternative measures of time-varying inflation uncertainty for these countries, using actual inflation data and survey expectations. I discuss some possible determinants of inflation uncertainty. Finally, I use panel data methods to investigate the relationship between term premium estimates and inflation uncertainty measures, and find a strong positive relationship. The economic determinants of term premia remain mysterious; but this evidence points to uncertainty about intermediate- to long-run inflation rates being a substantial part of the explanation for why yield curves slope up.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2008-25.

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Date of creation: 2008
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Handle: RePEc:fip:fedgfe:2008-25

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Keywords: Inflation (Finance) ; Bonds - Prices;

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  1. Robert Rich & Joseph Tracy, 2006. "The relationship between expected inflation, disagreement, and uncertainty: evidence from matched point and density forecasts," Staff Reports 253, Federal Reserve Bank of New York.
  2. Linda S. Goldberg & Michael W. Klein, 2005. "Establishing credibility: evolving perceptions of the European Central Bank," Staff Reports 231, Federal Reserve Bank of New York.
  3. Froot, Kenneth A, 1989. " New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 44(2), pages 283-305, June.
  4. Meredith J. Beechey & Benjamin K. Johannsen & Andrew T. Levin, 2011. "Are Long-Run Inflation Expectations Anchored More Firmly in the Euro Area Than in the United States?," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(2), pages 104-29, April.
  5. Monika Piazzesi & Martin Schneider, 2006. "Equilibrium Yield Curves," NBER Working Papers 12609, National Bureau of Economic Research, Inc.
    • Monika Piazzesi & Martin Schneider, 2007. "Equilibrium Yield Curves," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 389-472 National Bureau of Economic Research, Inc.
  6. Rich, R W & Raymond, J E & Butler, J S, 1992. "The Relationship between Forecast Dispersion and Forecast Uncertainty: Evidence from a Survey Data-ARCH Model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(2), pages 131-48, April-Jun.
  7. James H. Stock & Mark W. Watson, 2006. "Why Has U.S. Inflation Become Harder to Forecast?," NBER Working Papers 12324, National Bureau of Economic Research, Inc.
  8. Andrew T. Levin & Jeremy M. Piger, 2003. "Is inflation persistence intrinsic in industrial economies?," Working Papers 2002-023, Federal Reserve Bank of St. Louis.
  9. Andrew Ang & Geert Bekaert & Min Wei, 2005. "Do Macro Variables, Asset Markets or Surveys Forecast Inflation Better?," NBER Working Papers 11538, National Bureau of Economic Research, Inc.
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  13. Bacchetta, Philippe & Mertens, Elmar & van Wincoop, Eric, 2009. "Predictability in financial markets: What do survey expectations tell us?," Journal of International Money and Finance, Elsevier, vol. 28(3), pages 406-426, April.
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  15. Luis M. Viceira & Adi Sunderam & John Y. Campbell, 2008. "Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds," 2008 Meeting Papers 355, Society for Economic Dynamics.
  16. Monika Piazzesi & Martin Schneider, 2008. "Bond positions, expectations, and the yield curve," Working Paper 2008-02, Federal Reserve Bank of Atlanta.
  17. Kozicki, Sharon & Tinsley, P. A., 2001. "Shifting endpoints in the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 613-652, June.
  18. Refet S. G├╝rkaynak & Andrew T. Levin & Eric T. Swanson, 2006. "Does inflation targeting anchor long-run inflation expectations? evidence from long-term bond yields in the U.S., U.K., and Sweden," Working Paper Series 2006-09, Federal Reserve Bank of San Francisco.
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  21. Andrew Ang & Monika Piazzesi, 2001. "A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables," NBER Working Papers 8363, National Bureau of Economic Research, Inc.
  22. Meredith J. Beechey, 2008. "Lowering the anchor: how the Bank of England's inflation-targeting policies have shaped inflation expectations and perceptions of inflation risk," Finance and Economics Discussion Series 2008-44, Board of Governors of the Federal Reserve System (U.S.).
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Cited by:
  1. Jonas Dovern & Ulrich Fritsche & Jiri Slacalek, 2012. "Disagreement Among Forecasters in G7 Countries," The Review of Economics and Statistics, MIT Press, vol. 94(4), pages 1081-1096, November.
  2. Michael T. Kiley, 2008. "Inflation expectations, uncertainty, the Phillips curve, and monetary policy - comments," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 53.

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