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Inflation risk premium: evidence from the TIPS market

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  • Olesya V. Grishchenko
  • Jing-zhi Huang

Abstract

``Inflation-indexed securities would appear to be the most direct source of information about inflation expectations and real interest rates\\" (Bernanke, 2004). In this paper we study the term structure of real interest rates, expected inflation and inflation risk premia using data on prices of Treasury Inflation Protected Securities (TIPS) over the period 2000-2008. The approach we use to estimate inflation risk premium is arbitrage free, largely model free, and easy to implement. We also make distinction between TIPS yields and real yields and take into account explicitly the three-month indexation lag of TIPS in the analysis. In addition, we propose a new liquidity measure based on TIPS prices. Accounting for it, we find that the inflation risk premium is time-varying: it is negative (positive) in the first (second) half of the sample period. The average 10-year inflation risk premium ranges from -16 to 10 basis points over the full sample depending on the proxy used for expected inflation. More specifically, the estimates of the 10-year inflation risk premium range between 14 and 19 basis points for 2004-2008 period.

Suggested Citation

  • Olesya V. Grishchenko & Jing-zhi Huang, 2012. "Inflation risk premium: evidence from the TIPS market," Finance and Economics Discussion Series 2012-06, Board of Governors of the Federal Reserve System (US), revised 2012.
  • Handle: RePEc:fip:fedgfe:2012-06
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    References listed on IDEAS

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    6. Robert Jarrow & Yildiray Yildirim, 2008. "Pricing Treasury Inflation Protected Securities and Related Derivatives using an HJM Model," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 16, pages 349-370, World Scientific Publishing Co. Pte. Ltd..
    7. Refet S. Gürkaynak & 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.
    8. Robert Mundell, 1963. "Inflation and Real Interest," Journal of Political Economy, University of Chicago Press, vol. 71, pages 280-280.
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    10. Chernov, Mikhail & Mueller, Philippe, 2012. "The term structure of inflation expectations," Journal of Financial Economics, Elsevier, vol. 106(2), pages 367-394.
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