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Real risk, inflation risk, and the term structure

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  • Martin D. D. Evans

Abstract

I present a model for the term structures of nominal and real interest rates in the UK that incorporates Markov-switching and allows for non-neutralities, nonlinear dynamics, and flexibility in the dynamics of the risk premia. The model is used to assess how accurately the term structure reflects changing expectations of future yields and inflation. I find that variations in inflation expected over the next two to three years are very accurately reflected by current yields. Over longer horizons, the term structures closely track changing expectations regarding future nominal and real yields but not future inflation. Copyright 2003 Royal Economic Society.

Suggested Citation

  • Martin D. D. Evans, 2003. "Real risk, inflation risk, and the term structure," Economic Journal, Royal Economic Society, vol. 113(487), pages 345-389, April.
    • Handle: RePEc:ecj:econjl:v:113:y:2003:i:487:p:345-389
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System

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