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Inflation-Indexed Bonds and the Expectations Hypothesis

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  • Carolin E. Pflueger
  • Luis M. Viceira

Abstract

This paper empirically analyzes the Expectations Hypothesis (EH) in inflation-indexed (or real) bonds and in nominal bonds in the US and in the UK. We strongly reject the EH in inflation-indexed bonds, and also confirm and update the existing evidence rejecting the EH in nominal bonds. This rejection implies that the risk premium on both real and nominal bonds varies predictably over time. We also find strong evidence that the spread between the nominal and the real bond risk premium, or the break-even inflation risk premium, also varies over time. We argue that the time variation in real bond risk premia mostly likely reflects both a changing real interest rate risk premium and a changing liquidity risk premium, and that the variability in the nominal bond risk premia reflects a changing inflation risk premium. We estimate significant time series variability in the magnitude and sign of bond risk premia.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16903.

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Date of creation: Mar 2011
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Publication status: published as Carolin E. Pflueger & Luis M. Viceira, 2011. "Inflation-Indexed Bonds and the Expectations Hypothesis," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 139-158, December.
Handle: RePEc:nbr:nberwo:16903

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  1. Robin Greenwood & Dimitri Vayanos, 2010. "Price Pressure in the Government Bond Market," American Economic Review, American Economic Association, vol. 100(2), pages 585-90, May.
  2. Buraschi, Andrea & Jiltsov, Alexei, 2005. "Inflation risk premia and the expectations hypothesis," Journal of Financial Economics, Elsevier, vol. 75(2), pages 429-490, February.
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Cited by:
  1. Samuel G. Hanson & Jeremy C. Stein, 2012. "Monetary policy and long-term real rates," Finance and Economics Discussion Series 2012-46, Board of Governors of the Federal Reserve System (U.S.).
  2. Kitsul, Yuriy & Wright, Jonathan H., 2013. "The economics of options-implied inflation probability density functions," Journal of Financial Economics, Elsevier, vol. 110(3), pages 696-711.
  3. Yuriy Kitsul & Jonathan H. Wright, 2012. "The Economics of Options-Implied Inflation Probability Density Functions," NBER Working Papers 18195, National Bureau of Economic Research, Inc.
  4. Francisco Palomino & Alex Hsu, 2013. "What do Nominal Rigidities and Monetary Policy tell us about the Real Yield Curve?," 2013 Meeting Papers 50, Society for Economic Dynamics.
  5. Olesya V. Grishchenko & Joel M. Vanden & Jianing Zhang, 2013. "The informational content of the embedded deflation option in TIPS," Finance and Economics Discussion Series 2013-24, Board of Governors of the Federal Reserve System (U.S.).

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