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Investigating Excess Returns from Nominal Bonds

Author

Listed:
  • Francis Breedon

    (Imperial College and Lehman Bros, London)

  • Jagjit S. Chadha

    (University of Cambridge)

Abstract

Estimated real returns on nominal bonds show excess returns of some 200 bp over their index--linked equivalent. This paper considers two possible explanations for this large difference. First, we assess the likely inflation risk premium by calibrating a model of optimal bond prices under uncertainty. Employing either of CRRA or Abel (1990) relative consumption utility function to derive the stochastic discount factor and covariation risk, we suggest that the inflation risk component of this excess return is unlikely to be much above 50 bp. Secondly, we find little evidence that these excess returns can be ascribed to consistent expectational errors in predicting inflation. Copyright Blackwell Publishing Ltd, 2003.

Suggested Citation

  • Francis Breedon & Jagjit S. Chadha, 2003. "Investigating Excess Returns from Nominal Bonds," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 65(1), pages 73-90, February.
  • Handle: RePEc:bla:obuest:v:65:y:2003:i:1:p:73-90
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    Cited by:

    1. Andrew Adams & Seth Armitage & Adrian FitzGerald, 2011. "Stock market volatility in a simple framework," CFI Discussion Papers 1101, Centre for Finance and Investment, Heriot Watt University.
    2. Peter S. Spiro, 2003. "Evidence on inflation expectations from Canadian real return bonds," Macroeconomics 0312004, EconWPA.
    3. Jagjit S. Chadha, 2012. "World Real Interest Rates: A Tale of Two Regimes," Studies in Economics 1205, School of Economics, University of Kent.
    4. Kanas, Angelos, 2014. "Bond futures, inflation-indexed bonds, and inflation risk premium," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 28(C), pages 82-99.

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