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Price discovery on traded inflation expectations: does the financial crisis matter?

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  • Schulz, Alexander
  • Stapf, Jelena
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    Abstract

    We analyze contributions of different markets to price discovery on traded inflation expectations and how it changed during the financial crisis. The quicker information is processed on one market and the less one market is disrupted by the financial crisis the more valuable is its information for central banks and market participants. We use a new high frequency data set on inflation-indexed and nominal government bonds as well as inflation swaps to calculate information shares of break-even inflation rates in the euro area and the US. For maturities up to 5 years new information comes from both the swap and the bond markets. For longer maturities the swap market provides less and less information in the euro area. In the US where the market volume of inflation-linked bonds is large the bond market dominates the price discovery process for all maturities. The severe financial crisis that spread out in Autumn 2008 drove a wedge between bond and swap break-even inflation rates in both currencies. Price discovery ceased to take place on the swap market. Disruptions coming from the short-end of the market even separated price formation on both segments for maturities of up to 6 years in the US. Against the backdrop of the most severe financial crisis in decades contributions to price formation concentrated a lot more on the presumably safest financial instrument: government bonds. --

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    Bibliographic Info

    Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2009,25.

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    Date of creation: 2009
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    Handle: RePEc:zbw:bubdp1:200925

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    Keywords: Inflation-linked bonds; inflation swaps; price discovery; financial crisis;

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    1. Ejsing, Jacob & García, Juan Angel & Werner, Thomas, 2007. "The term structure of euro area break-even inflation rates: the impact of seasonality," Working Paper Series 0830, European Central Bank.
    2. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York.
    3. John Y. Campbell & Robert J. Shiller & Luis M. Viceira, 2009. "Understanding Inflation-Indexed Bond Markets," Cowles Foundation Discussion Papers 1696, Cowles Foundation for Research in Economics, Yale University.
    4. Baillie, Richard T. & Geoffrey Booth, G. & Tse, Yiuman & Zabotina, Tatyana, 2002. "Price discovery and common factor models," Journal of Financial Markets, Elsevier, vol. 5(3), pages 309-321, July.
    5. Roberto Blanco & Simon Brennan & Ian W Marsh, 2004. "An empirical analysis of the dynamic relationship between investment-grade bonds and credit default swaps," Bank of England working papers 211, Bank of England.
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    7. Bruce Mizrach & Christopher J. Neely, 2007. "Information shares in the U.S. treasury market," Working Papers 2005-070, Federal Reserve Bank of St. Louis.
    8. Jun Liu & Francis A. Longstaff & Ravit E. Mandell, 2006. "The Market Price of Risk in Interest Rate Swaps: The Roles of Default and Liquidity Risks," The Journal of Business, University of Chicago Press, vol. 79(5), pages 2337-2360, September.
    9. Hakkio, Craig S. & Rush, Mark, 1991. "Cointegration: how short is the long run?," Journal of International Money and Finance, Elsevier, vol. 10(4), pages 571-581, December.
    10. Grammig, Joachim G. & Peter, Franziska J., 2008. "International price discovery in the presence of market microstructure effects," CFR Working Papers 08-10, University of Cologne, Centre for Financial Research (CFR).
    11. Christian Upper & Thomas Werner, 2007. "The tail wags the dog: time-varying information shares in the Bund market," BIS Working Papers 224, Bank for International Settlements.
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