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The term structure and inflation uncertainty

Author

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  • Breach, Tomas
  • D’Amico, Stefania
  • Orphanides, Athanasios
Abstract
To assess the importance of inflation risk for nominal Treasury yields, a novel quadratic term structure model with time-varying inflation risk is estimated using survey-based inflation uncertainty. The resulting yield decomposition captures very diverse macroeconomic dynamics of inflation and real risk premiums (large and positive during the 1980s but small and negative post-2008) and generates sensible high-frequency estimates of expected inflation and real short rates over a long sample. The explicit link between the model-implied factors and macro fundamentals reveals that short- but not long-run fluctuations are unspanned by yields, consistent with an interest rate policy unresponsive to transient inflation shocks.

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  • Breach, Tomas & D’Amico, Stefania & Orphanides, Athanasios, 2020. "The term structure and inflation uncertainty," Journal of Financial Economics, Elsevier, vol. 138(2), pages 388-414.
    • Handle: RePEc:eee:jfinec:v:138:y:2020:i:2:p:388-414
    DOI: 10.1016/j.jfineco.2020.04.013
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    Cited by:

    1. Phuong Ngo & Francois Gourio, 2016. "Risk Premia at the ZLB: a macroeconomic interpretation," 2016 Meeting Papers 1585, Society for Economic Dynamics.
    2. Zohar, Osnat, 2024. "Cyclicality of uncertainty and disagreement," Journal of Monetary Economics, Elsevier, vol. 143(C).
    3. Abraham Lioui & Andrea Tarelli, 2023. "Money Illusion and TIPS Demand," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 55(1), pages 171-214, February.
    4. Li, Junye & Sarno, Lucio & Zinna, Gabriele, 2024. "Risks and risk premia in the US Treasury market," Journal of Economic Dynamics and Control, Elsevier, vol. 158(C).
    5. Huang, Dashan & Jiang, Fuwei & Li, Kunpeng & Tong, Guoshi & Zhou, Guofu, 2023. "Are bond returns predictable with real-time macro data?," Journal of Econometrics, Elsevier, vol. 237(2).
    6. Ding Dong & Zheng Liu & Pengfei Wang & Min Wei, 2024. "Inflation Disagreement Weakens the Power of Monetary Policy," Working Paper Series 2024-27, Federal Reserve Bank of San Francisco.
    7. Karahan, Cenk C. & Soykök, Emre, 2022. "Term premium dynamics in an emerging market: Risk, liquidity, and behavioral factors," International Review of Financial Analysis, Elsevier, vol. 84(C).
    8. Stefania D’Amico & N Aaron Pancost, 2022. "Special Repo Rates and the Cross-Section of Bond Prices: The Role of the Special Collateral Risk Premium [Pr icing the term structure with linear regressions]," Review of Finance, European Finance Association, vol. 26(1), pages 117-162.
    9. Mauro Sayar Ferreira & Joice Marques Figueiredo, 2024. "The influence of global uncertainty and financial shocks, and sovereign risk shock on the Brazilian term structure of interest rate," Textos para Discussão Cedeplar-UFMG 674, Cedeplar, Universidade Federal de Minas Gerais.

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    More about this item

    Keywords

    Quadratic-Gaussian term structure models; Inflation risk premium; Survey forecasts; Hidden factors;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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