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Who Bears Long-Run Inflation Risk? Implications for Bond Risk Premia

Author

Listed:
  • Harold Cole

    (University of Pennsylvania)

  • Hanno Lustig

    (Anderson School of Business)

  • YiLi Chien

    (Federal Reserve Bank of St. Louis)

Abstract

U.S. financial institutions have traditionally insured the typical U.S. household against persistent shocks to U.S. inflation through the U.S. mortgage market. The bond risk premium is effectively the price of long-run inflation risk insurance charged by these U.S. intermediaries. Starting in the late 90's, these intermediaries have increasingly re-sold their U.S. inflation risk exposure to new market participants. We explore the equilibrium implications for bond return predictability in a segmented markets model of the bond market. These changes can account for the recent changes in bond return predictability.

Suggested Citation

  • Harold Cole & Hanno Lustig & YiLi Chien, 2013. "Who Bears Long-Run Inflation Risk? Implications for Bond Risk Premia," 2013 Meeting Papers 449, Society for Economic Dynamics.
  • Handle: RePEc:red:sed013:449
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