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Swapping Headline for Core Inflation: An Asset Liability Management Approach

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  • Fulli-Lemaire, Nicolas
  • Palidda, Ernesto

Abstract

Headline inflation in most industrialized countries, the US in particular, has been shown to be mean reverting to core inflation in the medium term, whilst at the same time the pass-through of exogenous commodity price shocks from the headline to the core has dramatically gone down as a result of a major macroeconomic paradigm change. It yields lower relative volatility for the latter and creates a drive for investing in commodities as a hedge for the spread between both inflation measures. In this paper, we argue for a risk reduction in ALM strategy in the form of a shift from targeting core rather than headline inflation for long-term hedgers while proposing an overlaying core versus headline swap to hedge the potential asset-liability gap. A market curve for core inflation could be derived from the trading of these derivatives and enable easy mark-to-market valuation of any core-linked securities, thus easing the way for future primary issues. Any supply and demand market disequilibria between long-term sellers of headline inflation and short-term sellers of core inflation could be matched by the intermediation of market makers which could price the derivative based on the cross-hedging potential of commodities.

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File URL: http://mpra.ub.uni-muenchen.de/43653/
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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 42853.

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Date of creation: 07 Aug 2012
Date of revision: 16 Nov 2012
Handle: RePEc:pra:mprapa:42853

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Related research

Keywords: ALM; LDI; Long-term Investment; Inflation Hedging; Core Inflation; Commodities; Inflation Pass-through; Arbitrage Pricing; Synthetic Futures; Inflation Derivative;

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References

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  1. Mark A. Wynne, 2008. "Core inflation: a review of some conceptual issues," Review, Federal Reserve Bank of St. Louis, issue May, pages 205-228.
  2. Fulli-Lemaire, Nicolas, 2012. "Allocating Commodities in Inflation Hedging Portfolios: A Core Driven Global Macro Strategy," MPRA Paper 42852, University Library of Munich, Germany, revised 15 Oct 2012.
  3. Ben S. Bernanke & Kenneth Rogoff, 2002. "NBER Macroeconomics Annual 2001, Volume 16," NBER Books, National Bureau of Economic Research, Inc, number bern02-1, May.
  4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  5. Paul van den Noord & Christophe André, 2007. "Why has Core Inflation Remained so Muted in the Face of the Oil Shock?," OECD Economics Department Working Papers 551, OECD Publishing.
  6. Hamilton, James D, 1983. "Oil and the Macroeconomy since World War II," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 228-48, April.
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Cited by:
  1. Fulli-Lemaire, Nicolas, 2012. "Alternative Inflation Hedging Portfolio Strategies: Going Forward Under Immoderate Macroeconomics," MPRA Paper 42854, University Library of Munich, Germany.
  2. Fulli-Lemaire, Nicolas, 2012. "Allocating Commodities in Inflation Hedging Portfolios: A Core Driven Global Macro Strategy," MPRA Paper 42852, University Library of Munich, Germany, revised 15 Oct 2012.
  3. Fulli-Lemaire, Nicolas, 2013. "Alternative inflation hedging strategies for ALM," MPRA Paper 43755, University Library of Munich, Germany.

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