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Breakeven inflation rates and their puzzling correlation relationships

  • Cette, G.
  • De Jong, M.

It is generally assumed that the two Fisher components of the interest rate -the real interest and the inflation- evolve independently over time, considering that they are driven by unrelated economical events. However, the market pricing of those components deduced from newly-available bond data does not provide conclusive evidence. While studying the price behaviour of inflation-linked (real) bonds beside nominal bonds in the major fixed-income markets, we observe that the real bond yields and the yield differentials, the breakeven inflation rates, have the propensity to be positively correlated between each other across the various countries, yet are pushed into a negative correlation relationship due to market-related price distortions. As long as those distortions are local, the net result is near-zero correlation within countries; when they become global, as in the heat of the current crisis, the correlations turn negative worldwide. In this paper insight is gained by taking an innovative worldwide study approach and thanks to revealing crisis period events.

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Paper provided by Banque de France in its series Working papers with number 367.

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Length: 17 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:bfr:banfra:367
Contact details of provider: Postal: Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS
Web page: http://www.banque-france.fr/

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  1. Marielle de Jong & Gilbert Cette, 2008. "The rocky ride of break-even inflation rates," Economics Bulletin, AccessEcon, vol. 5(31), pages 1-8.
  2. Ejsing, Jacob & García, Juan Angel & Werner, Thomas, 2007. "The term structure of euro area break-even inflation rates: the impact of seasonality," Working Paper Series 0830, European Central Bank.
  3. John Y. Campbell & Robert J. Shiller & Luis M. Viceira, 2009. "Understanding Inflation-Indexed Bond Markets," Cowles Foundation Discussion Papers 1696, Cowles Foundation for Research in Economics, Yale University.
  4. William R. Emmons, 2000. "The information content of Treasury inflation-indexed securities," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 25-38.
  5. Agathe Côté & Jocelyn Jacob & John Nelmes & Miles Whittingham, 1996. "Inflation expectations and Real Return Bonds," Bank of Canada Review, Bank of Canada, vol. 1996(Summer), pages 41-53.
  6. Arusha Cooray, 2002. "The Fisher Effect: A Review of the Literature," Research Papers 0206, Macquarie University, Department of Economics.
  7. Hördahl, Peter & Tristani, Oreste, 2007. "Inflation risk premia in the term structure of interest rates," Working Paper Series 0734, European Central Bank.
  8. Geert Bekaert & Xiaozheng Wang, 2010. "Inflation risk and the inflation risk premium," Economic Policy, CEPR;CES;MSH, vol. 25, pages 755-806, October.
  9. Christensen, Ian & Frédéric Dion & Christopher Reid, 2004. "Real Return Bonds, Inflation Expectations, and the Break-Even Inflation Rate," Working Papers 04-43, Bank of Canada.
  10. Brian Sack & Robert Elsasser, 2004. "Treasury inflation-indexed debt: a review of the U.S. experience," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 47-63.
  11. repec:ebl:ecbull:v:5:y:2008:i:31:p:1-8 is not listed on IDEAS
  12. Hunter, Delroy M. & Simon, David P., 2005. "Are TIPS the "real" deal?: A conditional assessment of their role in a nominal portfolio," Journal of Banking & Finance, Elsevier, vol. 29(2), pages 347-368, February.
  13. Pu Shen, 2006. "Liquidity risk premia and breakeven inflation rates," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 29-54.
  14. Refet S. G�rkaynak & Brian Sack & Jonathan H. Wright, 2010. "The TIPS Yield Curve and Inflation Compensation," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(1), pages 70-92, January.
  15. Martin D. D. Evans, 1998. "Real Rates, Expected Inflation, and Inflation Risk Premia," Journal of Finance, American Finance Association, vol. 53(1), pages 187-218, 02.
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