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

Kajuth, Florian and Watzka, Sebastian (2008): Inflation expectations from index-linked bonds: Correcting for liquidity and inflation risk premia. Discussion Papers in Economics 2008-13

Abstract

We provide a critical assessment of the method used by the Cleveland Fed to correct expected inflation derived from index-linked bonds for liquidity and inflation risk premia and show how their method can be adapted to account for time-varying inflation risk premia. Furthermore, we show how sensitive the Cleveland Fed approach is to different measures of the liquidity premium. In addition we propose an alternative approach to decompose the bias in inflation expectations derived from index-linked bonds using a state-space estimation. Our results show that once one accounts for time-varying liquidity and inflation risk premia current 10-year U.S. inflation expectations are lower than estimated by the Cleveland Fed.

• Item Type: Paper (Discussion Paper)
• Status: Preprint
• Keywords: Inflation expectations, liquidity risk premium, inflation risk premium, treasury inflation-protected securities (TIPS), state-space model
• Collections: Economics; Economics > Discussion Papers in Economics; Economics > Discussion Papers in Economics > Macro-Economics; Economics > Discussion Papers in Economics > Money; Economics > Discussion Papers in Economics > Financial Markets
• Subjects: 300 Social sciences > 300 Social sciences, sociology and anthropology; 300 Social sciences > 330 Economics
• JEL Classification: E31, E52, G12
• Language: English