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Inflation risk in the U.S. yield curve: the usefulness of indexed bonds


  • Frank F. Gong
  • Eli M. Remolona


The inflation-indexed bonds the U.S. Treasury plans to issue will reduce the expected borrowing cost if the yield curve reflects a risk premium for inflation. In the United Kingdom, indexed bonds are also used to extract inflationary expectations and thus to guide monetary policy. The bonds will produce a more reliable measure of such expectations if the inflation risk premium is taken into account. We estimate such a risk premium for the United States by means of a two-factor affine-yield model of the term structure. The model allows both the inflation risk premium and real term premium to vary over time. Using monthly data on CPI inflation and on bond yields for two-year to ten-year maturities, we find both premia to have been significant for the sample period January 1984 to July 1996. We estimate that indexed bonds would have saved an average of one-fifth of the expected borrowing cost of 10-year notes.

Suggested Citation

  • Frank F. Gong & Eli M. Remolona, 1996. "Inflation risk in the U.S. yield curve: the usefulness of indexed bonds," Research Paper 9637, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednrp:9637

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    References listed on IDEAS

    1. Eric M. Leeper, 1992. "Consumer attitudes: king for a day," Economic Review, Federal Reserve Bank of Atlanta, issue Jul, pages 1-15.
    2. Carroll, Christopher D & Fuhrer, Jeffrey C & Wilcox, David W, 1994. "Does Consumer Sentiment Forecast Household Spending? If So, Why?," American Economic Review, American Economic Association, vol. 84(5), pages 1397-1408, December.
    3. Wilcox, David W, 1992. "The Construction of U.S. Consumption Data: Some Facts and Their Implications for Empirical Work," American Economic Review, American Economic Association, vol. 82(4), pages 922-941, September.
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    Cited by:

    1. Kanas, Angelos, 2014. "Bond futures, inflation-indexed bonds, and inflation risk premium," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 28(C), pages 82-99.
    2. Nuno Cassola & Jorge Barros Luis, 2003. "A two-factor model of the German term structure of interest rates," Applied Financial Economics, Taylor & Francis Journals, vol. 13(11), pages 783-806.
    3. LuisM. Viceira & John Y. Campbell, 2001. "Who Should Buy Long-Term Bonds?," American Economic Review, American Economic Association, vol. 91(1), pages 99-127, March.
    4. Juan Angel Garcia & Adrian van Rixtel, 2007. "Inflation-linked bonds from a central bank perspective," Occasional Papers 0705, Banco de España;Occasional Papers Homepage.
    5. Reschreiter, Andreas, 2004. "Conditional funding costs of inflation-indexed and conventional government bonds," Journal of Banking & Finance, Elsevier, vol. 28(6), pages 1299-1318, June.
    6. Barros Luís, Jorge & Cassola, Nuno, 2001. "A two-factor model of the German term structure of interest rates," Working Paper Series 0046, European Central Bank.
    7. Reschreiter, Andreas, 2008. "Lower borrowing costs with inflation-indexed bonds: A trading rule based assessment," Economics Letters, Elsevier, vol. 99(2), pages 272-274, May.
    8. Fung, Ben & Mitnick, Scott & Remolona, Eli, 1999. "Uncovering Inflation Expectations and Risk Premiums From Internationally Integrated Financial Markets," Staff Working Papers 99-6, Bank of Canada.
    9. Madureira, Leonardo, 2007. "The ex ante real rate and inflation premium under a habit consumption model," Journal of Empirical Finance, Elsevier, vol. 14(3), pages 355-382, June.


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