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Inflation risk premia in the term structure of interest rates

  • Hördahl, Peter
  • Tristani, Oreste

This paper estimates the size and dynamics of inflation risk premia in the euro area, based on a joint model of macroeconomic and term structure dynamics. Information from both nominal and index-linked yields is used in the empirical analysis. Our results indicate that term premia in the euro area yield curve reflect pre-dominantly real risks, i.e. risks which affect the returns on both nominal and index-linked bonds. On average, inflation risk premia were negligible during the EMU period but, occasionally, subject to statistically significant fluctuations in 2004-2006. Movements in the raw break-even rate appear to have mostly reflected such variations in inflation risk premia, while long-term inflation expectations have remained remarkably anchored from 1999 to date. JEL Classification: E43, E44

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Paper provided by European Central Bank in its series Working Paper Series with number 0734.

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Date of creation: Feb 2007
Date of revision:
Handle: RePEc:ecb:ecbwps:20070734
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  1. Hördahl, Peter & Tristani, Oreste & Vestin, David, 2007. "The yield curve and macroeconomic dynamics," Working Paper Series 0832, European Central Bank.
  2. Peter Hordahl & Oreste Tristani & David Vestin, 2004. "A joint econometric model of macroeconomic and term structure dynamics," Money Macro and Finance (MMF) Research Group Conference 2003 48, Money Macro and Finance Research Group.
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  24. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
  25. Don H. Kim & Jonathan H. Wright, 2005. "An arbitrage-free three-factor term structure model and the recent behavior of long-term yields and distant-horizon forward rates," Finance and Economics Discussion Series 2005-33, Board of Governors of the Federal Reserve System (U.S.).
  26. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, vol. 83(3), pages 509-34, June.
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