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Inflation risk premium: evidence from the TIPS market

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  • Olesya V. Grishchenko
  • Jing-zhi Huang

Abstract

``Inflation-indexed securities would appear to be the most direct source of information about inflation expectations and real interest rates" (Bernanke, 2004). In this paper we study the term structure of real interest rates, expected inflation and inflation risk premia using data on prices of Treasury Inflation Protected Securities (TIPS) over the period 2000-2008. The approach we use to estimate inflation risk premium is arbitrage free, largely model free, and easy to implement. We also make distinction between TIPS yields and real yields and take into account explicitly the three-month indexation lag of TIPS in the analysis. In addition, we propose a new liquidity measure based on TIPS prices. Accounting for it, we find that the inflation risk premium is time-varying: it is negative (positive) in the first (second) half of the sample period. The average 10-year inflation risk premium ranges from -16 to 10 basis points over the full sample depending on the proxy used for expected inflation. More specifically, the estimates of the 10-year inflation risk premium range between 14 and 19 basis points for 2004-2008 period.

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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 2012-06.

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Date of creation: 2012
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Handle: RePEc:fip:fedgfe:2012-06

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  1. Albert Lee Chun, 2005. "Expectations, Bond Yields and Monetary Policy," Finance 0512006, EconWPA.
  2. John Y. Campbell & Luis M. Viceira, 1998. "Who Should Buy Long-Term Bonds?," NBER Working Papers 6801, National Bureau of Economic Research, Inc.
  3. Chernov, Mikhail & Mueller, Philippe, 2012. "The term structure of inflation expectations," Journal of Financial Economics, Elsevier, vol. 106(2), pages 367-394.
  4. Refet S. G�rkaynak & Jonathan H. Wright, 2012. "Macroeconomics and the Term Structure," Journal of Economic Literature, American Economic Association, vol. 50(2), pages 331-67, June.
  5. Robert Mundell, 1963. "Inflation and Real Interest," Journal of Political Economy, University of Chicago Press, vol. 71, pages 280.
  6. Buraschi, Andrea & Jiltsov, Alexei, 2005. "Inflation risk premia and the expectations hypothesis," Journal of Financial Economics, Elsevier, vol. 75(2), pages 429-490, February.
  7. Jarrow, Robert & Yildirim, Yildiray, 2003. "Pricing Treasury Inflation Protected Securities and Related Derivatives using an HJM Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(02), pages 337-358, June.
  8. Refet S. Gürkaynak & Brian Sack & Jonathan H. Wright, 2008. "The TIPS yield curve and inflation compensation," Finance and Economics Discussion Series 2008-05, Board of Governors of the Federal Reserve System (U.S.).
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