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Do Inflation-linked Bonds Contain Information about Future Inflation?

  • José Valentim Machado Vicente
  • Osmani Teixeira de Carvalho Guillen

There is a widespread belief that inflation-linked bonds are a direct source of information about inflation expectations. In this paper we address this issue by analyzing the relationship between break-even inflation (the difference between nominal and real yields) and future inflation. The dataset is extracted from Brazilian Treasury bonds covering the period from April 2005 to July 2010. We find that break-even inflation is an unbiased forecast only of the 3-month and 6-month ahead inflation. For medium horizons (12 and 18 months) break-even inflation has weak explanatory power of future inflation. Over long horizons (24 and 30 months), we report a significant, but counterintuitive, negative relationship between the break-even and realized inflations.

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File URL: http://www.bcb.gov.br/pec/wps/ingl/wps214.pdf
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Paper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 214.

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Date of creation: Oct 2010
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Handle: RePEc:bcb:wpaper:214
Contact details of provider: Web page: http://www.bcb.gov.br/?english

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  1. Joyce, Michael A.S. & Lildholdt, Peter & Sorensen, Steffen, 2010. "Extracting inflation expectations and inflation risk premia from the term structure: A joint model of the UK nominal and real yield curves," Journal of Banking & Finance, Elsevier, vol. 34(2), pages 281-294, February.
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  7. Almeida, Caio & Vicente, José, 2009. "Identifying volatility risk premia from fixed income Asian options," Journal of Banking & Finance, Elsevier, vol. 33(4), pages 652-661, April.
  8. Kenneth D. Garbade & Matthew Rutherford, 2007. "Buybacks in Treasury cash and debt management," Staff Reports 304, Federal Reserve Bank of New York.
  9. Peter Hördahl, 2008. "The inflation risk premium in the term structure of interest rates," BIS Quarterly Review, Bank for International Settlements, September.
  10. Olesya V. Grishchenko & Jing-zhi Huang, 2012. "Inflation risk premium: evidence from the TIPS market," Finance and Economics Discussion Series 2012-06, Board of Governors of the Federal Reserve System (U.S.).
  11. Jun Pan & Kenneth J. Singleton, 2008. "Default and Recovery Implicit in the Term Structure of Sovereign "CDS" Spreads," Journal of Finance, American Finance Association, vol. 63(5), pages 2345-2384, October.
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