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Term premiums and inflation uncertainty: empirical evidence from an international panel dataset

  • Jonathan H. Wright

This paper provides cross-country empirical evidence on term premia, inflation uncertainty, and their relationship. It has three components. First, I construct a panel of zero-coupon nominal government bond yields spanning ten countries and eighteen years. From these, I construct forward rates and decompose these into expected future short-term interest rates and term premiums, using both statistical methods (an affine term structure model) and using surveys. Second, I construct alternative measures of time-varying inflation uncertainty for these countries, using actual inflation data and survey expectations. I discuss some possible determinants of inflation uncertainty. Finally, I use panel data methods to investigate the relationship between term premium estimates and inflation uncertainty measures, and find a strong positive relationship. The economic determinants of term premia remain mysterious; but this evidence points to uncertainty about intermediate- to long-run inflation rates being a substantial part of the explanation for why yield curves slope up.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2008-25.

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Date of creation: 2008
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Handle: RePEc:fip:fedgfe:2008-25
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  1. Wachter, Jessica A., 2006. "A consumption-based model of the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 79(2), pages 365-399, February.
  2. Nicola Anderson & John Sleath, 2001. "New estimates of the UK real and nominal yield curves," Bank of England working papers 126, Bank of England.
  3. 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.
  4. Ang, Andrew & Bekaert, Geert & Wei, Min, 2007. "Do macro variables, asset markets, or surveys forecast inflation better?," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1163-1212, May.
  5. Beechey, Meredith J & Johannsen, Benjamin K & Levin, Andrew, 2007. "Are Long-Run Inflation Expectations Anchored More Firmly in the Euro Area than in the United States?," CEPR Discussion Papers 6536, C.E.P.R. Discussion Papers.
  6. Robert W. Rich & Joseph Tracy, 2006. "The relationship between expected inflation, disagreement, and uncertainty: evidence from matched point and density forecasts," Staff Reports 253, Federal Reserve Bank of New York.
  7. Andrew T. Levin & Jeremy M. Piger, 2003. "Is inflation persistence intrinsic in industrial economies?," Working Papers 2002-023, Federal Reserve Bank of St. Louis.
  8. Sharon Kozicki & Peter A. Tinsley, 1997. "Shifting endpoints in the term structure of interest rates," Research Working Paper 97-08, Federal Reserve Bank of Kansas City.
  9. G├╝rkaynak, Refet S. & Levin, Andrew & Swanson, Eric T, 2006. "Does Inflation Targeting Anchor Long-Run Inflation Expectations? Evidence from Long-Term Bond Yields in the US, UK and Sweden," CEPR Discussion Papers 5808, C.E.P.R. Discussion Papers.
  10. Monika Piazzesi & Martin Schneider, 2008. "Bond positions, expectations, and the yield curve," FRB Atlanta Working Paper 2008-02, Federal Reserve Bank of Atlanta.
  11. James H. Stock & Mark W. Watson, 2007. "Why Has U.S. Inflation Become Harder to Forecast?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 3-33, 02.
  12. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
  13. Monika Piazzesi & Martin Schneider, 2006. "Equilibrium Yield Curves," NBER Working Papers 12609, National Bureau of Economic Research, Inc.
    • Monika Piazzesi & Martin Schneider, 2007. "Equilibrium Yield Curves," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 389-472 National Bureau of Economic Research, Inc.
  14. Cukierman, Alex & Wachtel, Paul, 1979. "Differential Inflationary Expectations and the Variability of the Rate of Inflation: Theory and Evidence," American Economic Review, American Economic Association, vol. 69(4), pages 595-609, September.
  15. Mardi Dungey & Vance L Martin & Adrian R Pagan, 2000. "A multivariate latent factor decomposition of international bond yield spreads," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(6), pages 697-715.
  16. Linda S. Goldberg & Michael W. Klein, 2007. "Establishing Credibility: Evolving Perceptions of the European Central Bank," The Institute for International Integration Studies Discussion Paper Series iiisdp194, IIIS.
  17. Wachter, Jessica A., 2003. "Risk aversion and allocation to long-term bonds," Journal of Economic Theory, Elsevier, vol. 112(2), pages 325-333, October.
  18. Luis M. Viceira & Adi Sunderam & John Y. Campbell, 2008. "Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds," 2008 Meeting Papers 355, Society for Economic Dynamics.
  19. Philippe Bacchetta & Elmar Mertens & Eric van Wincoop, 2006. "Predictability in Financial Markets: What Do Survey Expectations Tell Us?," Working Papers 102006, Hong Kong Institute for Monetary Research.
  20. Kenneth A. Froot, 1987. "New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates," NBER Working Papers 2363, National Bureau of Economic Research, Inc.
  21. Rich, R W & Raymond, J E & Butler, J S, 1992. "The Relationship between Forecast Dispersion and Forecast Uncertainty: Evidence from a Survey Data-ARCH Model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(2), pages 131-48, April-Jun.
  22. Meredith J. Beechey, 2008. "Lowering the anchor: how the Bank of England's inflation-targeting policies have shaped inflation expectations and perceptions of inflation risk," Finance and Economics Discussion Series 2008-44, Board of Governors of the Federal Reserve System (U.S.).
  23. Dai, Qiang & Singleton, Kenneth J., 2002. "Expectation puzzles, time-varying risk premia, and affine models of the term structure," Journal of Financial Economics, Elsevier, vol. 63(3), pages 415-441, March.
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