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Inflation expectations from index-linked bonds: Correcting for liquidity and inflation risk premia

Listed author(s):
  • Kajuth, Florian
  • Watzka, Sebastian

We propose a novel method to correct break-even inflation rates derived from index-linked bonds for liquidity and inflation risk premia without resorting to survey based measures. In a state-space framework the difference between break-even inflation rates and unobserved true inflation expectation is explained by measures of time-varying liquidity and inflation risk premia. Our results have better forecasting performance for the average annual inflation rate over the following 10 years than raw break-even rates and the Survey of Professional Forecasters.

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Paper provided by University of Munich, Department of Economics in its series Munich Reprints in Economics with number 19535.

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Date of creation: 2011
Publication status: Published in Quarterly Review of Economics and Finance 3 51(2011): pp. 225-235
Handle: RePEc:lmu:muenar:19535
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  1. Dimitri Vayanos & Pierre-Olivier Weill, 2008. "A Search-Based Theory of the On-the-Run Phenomenon," Journal of Finance, American Finance Association, vol. 63(3), pages 1361-1398, 06.
  2. Peter Hördahl & Oreste Tristani, 2012. "Inflation Risk Premia In The Term Structure Of Interest Rates," Journal of the European Economic Association, European Economic Association, vol. 10(3), pages 634-657, May.
  3. Stefania D'Amico & Don H Kim & Min Wei, 2008. "Tips from TIPS: the informational content of Treasury Inflation-Protected Security prices," BIS Working Papers 248, Bank for International Settlements.
  4. Joseph G. Haubrich & George Pennacchi & Peter H. Ritchken, 2008. "Estimating real and nominal term structures using Treasury yields, inflation, inflation forecasts, and inflation swap rates," Working Paper 0810, Federal Reserve Bank of Cleveland.
  5. Kajuth, Florian & Watzka, Sebastian, 2011. "Inflation expectations from index-linked bonds: Correcting for liquidity and inflation risk premia," The Quarterly Review of Economics and Finance, Elsevier, vol. 51(3), pages 225-235, June.
  6. García, Juan Angel & Werner, Thomas, 2010. "Inflation risks and inflation risk premia," Working Paper Series 1162, European Central Bank.
  7. Fama, Eugene F. & Gibbons, Michael R., 1982. "Inflation, real returns and capital investment," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 297-323.
  8. Dean Croushore, 1993. "Introducing: the survey of professional forecasters," Business Review, Federal Reserve Bank of Philadelphia, issue Nov, pages 3-15.
  9. Paul Söderlind, 2011. "Inflation Risk Premia and Survey Evidence on Macroeconomic Uncertainty," International Journal of Central Banking, International Journal of Central Banking, vol. 7(2), pages 113-133, June.
  10. Stephen Leybourne & Tae-Hwan Kim & Vanessa Smith & Paul Newbold, 2003. "Tests for a change in persistence against the null of difference-stationarity," Econometrics Journal, Royal Economic Society, vol. 6(2), pages 291-311, December.
  11. John Y. Campbell & Robert J. Shiller & Luis M. Viceira, 2009. "Understanding Inflation-Indexed Bond Markets," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(1 (Spring), pages 79-138.
  12. Gurkaynak, Refet S. & Sack, Brian & Wright, Jonathan H., 2007. "The U.S. Treasury yield curve: 1961 to the present," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2291-2304, November.
  13. 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.
  14. Hördahl, Peter & Tristani, Oreste, 2010. "Inflation risk premia in the US and the euro area," Working Paper Series 1270, European Central Bank.
  15. Juan Angel Garcia & Adrian van Rixtel, 2007. "Inflation-linked bonds from a central bank perspective," Occasional Papers 0705, Banco de España;Occasional Papers Homepage.
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