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Real term structure and inflation compensation in the euro area

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  • Marcello Pericoli

    () (Bank of Italy)

Abstract

Estimates of the real term structure for the euro area implied by French index-linked bonds are obtained by means of a smoothing spline methodology. The real term structure allows computation of the constant-maturity inflation compensation, which is compared with the surveyed inflation expectations in order to obtain a rough measure of the inflation risk premium. The comparison between the inflation compensation and the inflation swap shows that the two variables are closely interlinked but differently affected by illiquidity during periods of stress. The methodology used in this paper is quite effective at capturing the general shape of the real term structure while smoothing through idiosyncratic variations in the yields of index-linked bonds. Real interest rates tend to be quite stable at longer horizons and the average 10-year real rate from 2002 to 2009 is close to 2 per cent. Furthermore, evidence is found that inflation compensation was held down in the period 2008-09 by an increase in the liquidity premium of index-linked bonds.

Suggested Citation

  • Marcello Pericoli, 2012. "Real term structure and inflation compensation in the euro area," Temi di discussione (Economic working papers) 841, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_841_12
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    References listed on IDEAS

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    Cited by:

    1. Gabriele Zinna, 2016. "Price Pressures on UK Real Rates: An Empirical Investigation," Review of Finance, European Finance Association, vol. 20(4), pages 1587-1630.
    2. Marcello Pericoli, 2012. "Expected inflation and inflation risk premium in the euro area and in the United States," Temi di discussione (Economic working papers) 842, Bank of Italy, Economic Research and International Relations Area.
    3. Covarrubias, Enrique & Hernández-del-Valle, Gerardo, 2016. "Inflation expectations derived from a portfolio model," MPRA Paper 69489, University Library of Munich, Germany.

    More about this item

    Keywords

    index-linked bond; real term structure; inflation compensation; inflation risk premium; smoothing spline;

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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