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Kajuth, Florian und Watzka, Sebastian (2011): Inflation expectations from index-linked bonds: Correcting for liquidity and inflation risk premia. In: Quarterly Review of Economics and Finance, Vol. 51, Nr. 3: S. 225-235

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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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