The Term Structure of Inflation Expectations

This paper quantitatively explores the role of external habits, nominal rigidities, and monetary policy for real and nominal bond yields in an asset-pricing endogenous growth model. The calibration captures the reported average positive slopes of U.S. real and nominal yield curves with sizable positive real and nominal bond risk premia. Habits are critical to generate positive real premia by altering the comovement of real rates and productivity shocks. Nominal rigidities generate monetary policy effects on real bonds. Stronger policy rule inflation responses or weaker output responses increase real term premia and reduce inflation risk premia. Relative to standard models, the paper provides an alternative interpretation of real and nominal bond risks. This paper was accepted by Tomasz Piskorski, finance.

Reactions of Real Yields and Inflation Expectations to Forward Guidance in the United States

PurposeThis paper aims to study the asset pricing implications for stock and bond markets in a long-run risks (LRR) model with regime shifts. This general equilibrium framework can not only generate sign-switching stock-bond correlations and bond risk premium, but also quantitatively reproduce various other salient empirical features in stock and bond markets, including time-varying equity and bond return premia, regime shifts in real and nominal yield curves, the violation of the expectations hypothesis of bond returns.Design/methodology/approachThe researchers study the joint determinants of stock and bond returns in a LRR model framework with regime shifts in consumption and inflation dynamics. In particular, the means, volatilities, and the correlation structure between consumption growth and inflation are regime-dependent.FindingsThe model shows that the term structure of interest rates and stock-bond correlation are intimately related to business cycles, while LRR play a more important role in accounting for high equity premium than do business cycle risks.Originality/valueThis paper studies the joint determinants of stock and bond returns in a Bansal and Yaron (2004) type of LRR framework. This rational expectations general equilibrium framework can (1) jointly match the dynamics of consumption, inflation and cash flow; (2) generate time-varying and sign-switching stock and bond correlations, as well as generating sign-switching bond risk premium; and (3) coherently explain another long list of salient empirical features in stock and bond markets, including time-varying equity and bond return premia, regime shifts in real and nominal yield curves, the violation of the expectations hypothesis of bond returns.

Extracting Inflation Expectations and Inflation Risk Premia from the Term Structure: A Joint Model of the UK Nominal and Real Yield Curves

A hybrid spline-based parametric model for the yield curve

A inflacao implicita (diferenca entre as taxas de juros nominal e real) e o principal indicador do nivel futuro de precos. No entanto, a expectativa de inflacao e apenas um dos seus componentes. Neste artigo nos apresentamos um modelo economico simples a fim de decompor a inflacao implicita nos seguintes fatores fundamentais: expectativa de inflacao, termo de convexidade e premios de liquidez e de risco de inflacao. Usando dados brasileiros de janeiro de 2006 a setembro de 2013, avaliamos cada um destes termos. As expectativas de inflacao sao lidas diretamente do Focus, uma pesquisa realizada pelo Banco Central do Brasil. Em nosso modelo, o termo de convexidade ou correcao de Jensen e igual a variância da taxa de inflacao. Reportamos um termo de convexidade muito pequeno, o que esta em consonância com a literatura internacional sobre o assunto. Sua magnitude e de cerca de um ponto base, inferior ao spread de compra e venda dos titulos de renda fixa brasileiros. Embora haja uma diferenca significativa entre os volumes de negociacao de titulos nominais e reais, essa diferenca de liquidez nao e aprecada (premio de liquidez nao e significativo). Este resultado, aparentemente contraditorio, ocorre porque no Brasil titulos reais sao geralmente mantidos ate o vencimento. Por isso os investidores nao exigem uma recompensa devido a exposicao a incerteza de liquidez, o que por sua vez elimina a relevância deste premio. Finalmente, nos mostramos que o premio de risco de inflacao e pequeno para horizontes curtos. Para horizontes longos este premio de risco e variavel no tempo e relacionado com o consumo e a volatilidade do mercado de acoes, em acordo com a teoria economica.

Regime Shifts in a Long-run Risks Model of U.S. Stock and Treasury Bond Markets

The links between real and nominal bond risk premia and macroeconomic dynamics are explored quantitatively in a model with nominal rigidities and monetary policy. The estimated model captures macroeconomic and yield curve properties of the U.S. economy, implying significantly positive real term and inflation risk bond premia. In contrast to previous literature, both premia are positive and generated by wage rigidities as a compensation for permanent productivity shocks. Stronger policy-rule responses to inflation (output) increase (decrease) both premia, while policy surprises generate negligible risk premia. Empirical evidence of the economic mechanism is provided.

Decomposing nominal and real yield curves and inflation forecasting: Evidence from Brazil

This paper develops a model of the term structures of nominal and real interest rates driven by state variables representing the short-term real interest rate, expected inflation, inflation’s central tendency, and four volatility factors that follow GARCH processes. We derive analytical solutions for nominal bond yields, yields on inflation-indexed bonds that have an indexation lag, and the term structure of expected inflation. Unlike prior studies, the model’s parameters are estimated using data on inflation swap rates, as well as nominal yields and survey forecasts of inflation. The volatility state variables fully determine bonds’ time varying risk premia and allow for stochastic volatility and correlation between bond yields, yet they have small effects on the cross section of nominal yields. Allowing for time-varying volatility is particularly important for real interest rate and expected inflation processes, but long-horizon real and inflation risk premia are relatively stable.

A Model-Independent Maximum Range for the Liquidity Correction of TIPS Yields

A multi-factor model with time-varying and seasonal risk premiums for the natural gas market

News Implied Volatility and Disaster Concerns

We propose a DSGE model with regime switching in the central bank’s inflation target to explain inflation compensation in the UK. Taking advantage of the well-documented change in UK monetary policy to adopt inflation targeting, we estimate our model using nominal and inflation-linked Treasury bond data from the UK from 1985 to 2007. We find that this model can account for the term structure of inflation compensation in the nominal yield curve by generating regime-dependent conditional expectations of future inflation.

The Relationship Between Oil Prices and Breakeven Inflation Rates