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Real term structure and inflation compensation in the euro area

  • Marcello Pericoli

    ()

    (Bank of Italy)

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.

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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 841.

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Date of creation: Jan 2012
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Handle: RePEc:bdi:wptemi:td_841_12
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