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Inflation-Indexed Bonds and the Expectations Hypothesis

  • Carolin E. Pflueger

    ()

    (Harvard Business School, Harvard University, Boston, Massachusetts 02163)

  • Luis M. Viceira

    ()

    (Harvard Business School, Harvard University, Boston, Massachusetts 02163
    National Bureau of Economic Research, Cambridge, Massachusetts 02138)

This review empirically analyzes the expectations hypothesis (EH) in inflation-indexed (or real) bonds and in nominal bonds in the United States and in the United Kingdom. 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 breakeven inflation risk premium, also varies over time. We argue that the time variation in real bond risk premia most 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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File URL: http://www.annualreviews.org/doi/abs/10.1146/annurev-financial-102710-144843
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Article provided by Annual Reviews in its journal Annual Review of Financial Economics.

Volume (Year): 3 (2011)
Issue (Month): 1 (December)
Pages: 139-158

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Handle: RePEc:anr:refeco:v:3:y:2011:p:139-158
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  1. Buraschi, Andrea & Jiltsov, Alexei, 2005. "Inflation risk premia and the expectations hypothesis," Journal of Financial Economics, Elsevier, vol. 75(2), pages 429-490, February.
  2. 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.
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