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Extracting Deflation Probability Forecasts from Treasury Yields

Author

Listed:
  • Jens H.E. Christensen

    (Federal Reserve Bank of San Francisco)

  • Jose A. Lopez

    (Federal Reserve Bank of San Francisco)

  • Glenn D. Rudebusch

    (Federal Reserve Bank of San Francisco)

Abstract

We construct probability forecasts for episodes of price deflation (i.e., a falling price level) using yields on nominal and real U.S. Treasury bonds. The deflation probability forecasts identify two “deflation scares” during the past decade: a mild one following the 2001 recession and a more serious one starting in late 2008 with the deepening of the financial crisis. The estimated deflation probabilities are generally consistent with those from macroeconomic models and surveys of professional forecasters, but they also provide high-frequency insight into the views of financial market participants. The probabilities can also be used to price the deflation protection option embedded in real Treasury bonds.

Suggested Citation

  • Jens H.E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2012. "Extracting Deflation Probability Forecasts from Treasury Yields," International Journal of Central Banking, International Journal of Central Banking, vol. 8(4), pages 21-60, December.
  • Handle: RePEc:ijc:ijcjou:y:2012:q:4:a:2
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    References listed on IDEAS

    as
    1. Christensen, Jens H.E. & Diebold, Francis X. & Rudebusch, Glenn D., 2011. "The affine arbitrage-free class of Nelson-Siegel term structure models," Journal of Econometrics, Elsevier, vol. 164(1), pages 4-20, September.
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    Citations

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    Cited by:

    1. Santiago García-Verdú & Manuel Ramos-Francia, 2016. "On the costs of deflation: a consumption-based approach," BIS Papers chapters,in: Bank for International Settlements (ed.), Inflation mechanisms, expectations and monetary policy, volume 89, pages 247-273 Bank for International Settlements.
    2. Andrade, Philippe & Fourel, Valère & Ghysels, Eric & Idier, Julien, 2014. "The financial content of inflation risks in the euro area," International Journal of Forecasting, Elsevier, vol. 30(3), pages 648-659.
    3. Grishchenko, Olesya V. & Vanden, Joel M. & Zhang, Jianing, 2016. "The informational content of the embedded deflation option in TIPS," Journal of Banking & Finance, Elsevier, vol. 65(C), pages 1-26.
    4. Jens H. E. Christensen & James M. Gillan, 2011. "A model-independent maximum range for the liquidity correction of TIPS yields," Working Paper Series 2011-16, Federal Reserve Bank of San Francisco.
    5. Scharnagl, Michael & Stapf, Jelena, 2015. "Inflation, deflation, and uncertainty: What drives euro-area option-implied inflation expectations, and are they still anchored in the sovereign debt crisis?," Economic Modelling, Elsevier, vol. 48(C), pages 248-269.
    6. Faust, Jon & Wright, Jonathan H., 2013. "Forecasting Inflation," Handbook of Economic Forecasting, Elsevier.
    7. Andrade, P. & Ghysels, E. & Idier, J., 2012. "Tails of Inflation Forecasts and Tales of Monetary Policy," Working papers 407, Banque de France.
    8. Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2016. "Pricing Deflation Risk with US Treasury Yields," Review of Finance, European Finance Association, vol. 20(3), pages 1107-1152.
    9. Mirdala, Rajmund, 2015. "Decomposing Euro Area Sovereign Debt Yields into Inflation Expectations and Expected Real Interest Rates," MPRA Paper 68866, University Library of Munich, Germany, revised Nov 2015.
    10. Scharnagl, Michael & Stapf, Jelena, 2014. "Inflation, deflation, and uncertainty: What drives euro area option-implied inflation expectations and are they still anchored in the sovereign debt crisis?," Discussion Papers 24/2014, Deutsche Bundesbank.
    11. Jens H. E. Christensen & James M. Gillan, 2011. "TIPS liquidity, breakeven inflation, and inflation expectations," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue june20.
    12. Ryan Niladri Banerjee & Aaron Mehrotra, 2018. "Deflation expectations," BIS Working Papers 699, Bank for International Settlements.
    13. Martin M. Andreasen & Jens H.E. Christensen & Simon Riddell, 1508. "The TIPS Liquidity Premium," CREATES Research Papers 2017-27, Department of Economics and Business Economics, Aarhus University.

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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