Inflation, Real Interest Rates, and the Bond Market: A Study of UK Nominal and Index-Linked Government Bond Prices

36 Pages Posted: 13 Sep 2000 Last revised: 29 Nov 2022

See all articles by David G. Barr

David G. Barr

Durham Business School

John Y. Campbell

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: November 1996

Abstract

This paper estimates expected future real interest rates and inflation rates from observed prices of UK government nominal and index-linked bonds. The estimation method takes account of imperfections in the indexation of UK index-linked bonds. It assumes that expected log returns on all bonds are equal, and that expected real interest rates and inflation follow simple time-series processes whose parameters can be estimated from the cross-section of bond prices. The extracted inflation expectations forecast actual future inflation more accurately than nominal yields do. The estimated real interest rate is highly variable at short horizons, but comparatively stable at long horizons. Changes in real rates and expected inflation are strongly negatively correlated at short horizons, but not at long horizons.

Suggested Citation

Barr, David G. and Campbell, John Y., Inflation, Real Interest Rates, and the Bond Market: A Study of UK Nominal and Index-Linked Government Bond Prices (November 1996). NBER Working Paper No. w5821, Available at SSRN: https://ssrn.com/abstract=225608

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John Y. Campbell

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