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The Market for Inflation Risk

Author

Listed:
  • Bahaj, Saleem
  • Czech, Robert
  • Ding, Sitong
  • Reis, Ricardo

Abstract

This paper uses transaction-level data on UK inflation swaps to characterize who buys and who sells insurance against higher inflation, and to introduce new measures of expected inflation. We find that this market is segmented: pension funds trade at long maturities, while hedge funds trade at short maturities, with dealer banks serving as the counterparty for both. We propose three novel identification strategies based on heteroskedasticity, granular instrumental variables, and sign restrictions to estimate demand and supply functions and separate expectations from frictions in segmented financial markets. Expected inflation is more firmly anchored at long maturities than what swap prices indicate, while prices for short maturity swaps are mostly driven by shocks to frictions. Prices in this market absorb new information quickly, and the supply of long maturity inflation protection is very elastic. We find a strong correlation across institutions between their survey-based expectations and their trading behavior.

Suggested Citation

  • Bahaj, Saleem & Czech, Robert & Ding, Sitong & Reis, Ricardo, 2025. "The Market for Inflation Risk," CEPR Discussion Papers 20157, Centre for Economic Policy Research.
    • Handle: RePEc:cpr:ceprdp:20157
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    Cited by:

    1. is not listed on IDEAS
    2. Rompolis, Leonidas S., 2025. "Quantitative easing, uncertainty, and risk aversion," Journal of Banking & Finance, Elsevier, vol. 177(C).
    3. Isaac Baley & Javier Turen, 2024. "Lumpy forecasts," Economics Working Papers 1898, Department of Economics and Business, Universitat Pompeu Fabra.
    4. Xavier Gabaix & Ralph S J Koijen & Robert Richmond & Motohiro Yogo, 2024. "Artificial intelligence and big holdings data: Opportunities for central banks," BIS Working Papers 1222, Bank for International Settlements.
    5. Braun, Robin & Miranda-Agrippino, Silvia & Saha, Tuli, 2025. "Measuring monetary policy in the UK: The UK monetary policy event-study database," Journal of Monetary Economics, Elsevier, vol. 149(C).
    6. Rodrigo Barria & Gabor Pinter, 2023. "Mispricing in inflation markets," Bank of England Staff Working Paper series 1034, Bank of England.

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General

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