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A Portfolio-Balance Model of Inflation and Yield Curve Determination

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  • Antonio Diez de los Rios

Abstract

We propose a portfolio-balance model of the yield curve in which inflation is determined through an interest rate rule that satisfies the Taylor principle. Because arbitrageurs care about their real wealth, they only absorb an increase in the supply of nominal bonds if they are compensated with an increase in their real rates of return. Since the Taylor principle implies that the real return on nominal bonds positively depends on inflation, inflation increases in equilibrium when there is an increase in the supply of nominal bonds to compensate arbitrageurs for the additional supply they have to hold. (JEL E43, E52, G12, H63)

Suggested Citation

  • Antonio Diez de los Rios, 2025. "A Portfolio-Balance Model of Inflation and Yield Curve Determination," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 15(2), pages 121-161.
    • Handle: RePEc:oup:rasset:v:15:y:2025:i:2:p:121-161.
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    File URL: http://hdl.handle.net/10.1093/rapstu/raae015
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    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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