A Market Based Approach to Inflation Expectations, Risk Premia and Real Interest Rates

42 Pages Posted: 24 Mar 2008

Date Written: 2008

Abstract

In this paper we approach the inflation expectations and the real interest rate by using the information contain in the yield curve. We decompose nominal interest rates into real risk-free rates, inflation expectations and risk premia using an affine model that takes as factors the observed inflation rate and the parameters generated in the zero yield curve estimation. Under this approach we could obtain a measure of inflation expectations free of any risk premia. Moreover in our estimation we avoid imposing arbitrary restrictions as is mandatory under other methodologies based on unobserved components.

The empirical exercise has been applied to an economy - like the Spanish one during the 90's - with an important convergence process and a change in the monetary policy regime. The results suggest that the evolution of inflation expectations has been smoother than was expected.

Keywords: Real interest rates, Risk Premium, Inflation expectations, Affine Model

JEL Classification: G12, E43, E44, C53

Suggested Citation

Gimeno, Ricardo and Marqués, J. Manuel, A Market Based Approach to Inflation Expectations, Risk Premia and Real Interest Rates (2008). Banco de España Working Paper No. 0802, Available at SSRN: https://ssrn.com/abstract=1106133 or http://dx.doi.org/10.2139/ssrn.1106133

Ricardo Gimeno (Contact Author)

Banco de España ( email )

Madrid 28014
Spain

J. Manuel Marqués

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

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