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Pricing-to-market with state-dependent pricing

  • Anthony Landry
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    This paper extracts information on inflation expectations, the real interest rate, and various risk premiums by exploring the underlying common factors among the actual inflation, University of Michigan consumer survey inflation forecast, yields on U.S. nominal Treasury bonds, and particularly, yields on Treasury Inflation Protected Securities (TIPS). Our findings suggest that a significant liquidity risk premium on TIPS exists, which leads to inflation expectations that are generally higher than the inflation compensation measure at the 10-year horizon. On the other hand, the estimated expected inflation is mostly lower than the consumer survey inflation forecast at the 12-month horizon. Survey participants slowly adjust their inflation forecasts in response to inflation changes. The nominal interest rate adjustment lags inflation movements, too. Our model also edges out a parsimonious seasonal AR(2) time series model in the one-step-ahead forecast of inflation.

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    File URL: http://dallasfed.org/assets/documents/research/papers/2007/wp0706.pdf
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    Paper provided by Federal Reserve Bank of Dallas in its series Working Papers with number 0706.

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    Date of creation: 2007
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    Handle: RePEc:fip:feddwp:0706
    Contact details of provider: Web page: http://www.dallasfed.org/
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