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Expected inflation and inflation risk premium in the euro area and in the United States

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  • Marcello Pericoli

    (Bank of Italy)

Abstract

This paper uses the celebrated no-arbitrage affine Gaussian term structure model applied to index-linked and standard government bonds to derive expected inflation rates and inflation risk premia, in the euro area and in the US. Maximum likelihood estimates show that the model describes the evolution of the nominal and real term structures by using three latent factors which can be interpreted as two real factors and one inflation factor. These provide important information on expected inflation and inflation risk premia. The results highlight some striking differences between the euro area and the US. In the US, forward inflation risk premia become sizable around the start of the late-2000s financial crisis and considerably increase just before the adoption of the first unconventional monetary policy measures in March 2009. By contrast, in the euro area forward inflation risk premia remain unchanged even after the adoption of the unconventional monetary policy measures following the most acute phases of the financial crisis, in October 2008 and in May 2010. However, long-term inflation expectations have been well anchored over the past years.

Suggested Citation

  • 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.
    • Handle: RePEc:bdi:wptemi:td_842_12
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    References listed on IDEAS

    as
    1. Marcello Pericoli, 2014. "Real Term Structure and Inflation Compensation in the Euro Area," International Journal of Central Banking, International Journal of Central Banking, vol. 10(1), pages 1-42, March.
    2. Marcello Pericoli & Marco Taboga, 2008. "Canonical Term‐Structure Models with Observable Factors and the Dynamics of Bond Risk Premia," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(7), pages 1471-1488, October.
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    7. 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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    11. Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2010. "Inflation Expectations and Risk Premiums in an Arbitrage-Free Model of Nominal and Real Bond Yields," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 143-178, September.
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    Cited by:

    1. Marcello Pericoli, 2019. "An assessment of recent trends in market-based expected iflation in the euro area," Questioni di Economia e Finanza (Occasional Papers) 542, Bank of Italy, Economic Research and International Relations Area.
    2. Stefano Neri & Giuseppe Ferrero, 2017. "Monetary policy in a low interest rate environment," Questioni di Economia e Finanza (Occasional Papers) 392, Bank of Italy, Economic Research and International Relations Area.
    3. Argyropoulos, Efthymios & Tzavalis, Elias, 2021. "The influence of real interest rates and risk premium effects on the ability of the nominal term structure to forecast inflation," The Quarterly Review of Economics and Finance, Elsevier, vol. 80(C), pages 785-796.

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    More about this item

    Keywords

    real and nominal term structure; inflation risk premium; affine term structure; Kalman filter;
    All these keywords.

    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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