Inflation Uncertainty and Disagreement in Bond Risk Premia

35 Pages Posted: 19 Dec 2014

See all articles by Stefania D'Amico

Stefania D'Amico

Federal Reserve Bank of Chicago

Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management; Asia School of Business

Date Written: November 2014

Abstract

This paper examines the relation between variations in perceived inflation uncertainty and bond premia. Using the subjective probability distributions available in the Survey of Professional Forecasters we construct a quarterly time series of average individual uncertainty about inflation forecasts since 1968. We show that this ex-ante measure of inflation uncertainty differs importantly from measures of disagreement regarding inflation forecasts and other proxies, such as model-based ex-post measures of macroeconomic risk. Inflation uncertainty is an important driver of bond premia, but the relation varies across inflation regimes. It is most important in the high-inflation regime early in the sample and the low-inflation regime over the last 15 years. Once the role of inflation uncertainty is accounted for, disagreement regarding inflation forecasts appears a much less important driver of bond premia.

Keywords: Survey expectations, probabilistic forecasts, heterogeneity, inflation uncertainty, bond risk premia

JEL Classification: E37, E44, E47, C53, G12

Suggested Citation

D'Amico, Stefania and Orphanides, Athanasios, Inflation Uncertainty and Disagreement in Bond Risk Premia (November 2014). FRB of Chicago Working Paper No. 2014-24, Available at SSRN: https://ssrn.com/abstract=2539715 or http://dx.doi.org/10.2139/ssrn.2539715

Stefania D'Amico (Contact Author)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=54058

Asia School of Business ( email )

Jalan Kuching, Kuala Lumpur, Wilayah Persekutuan K
Kuala Lumpur, MA
Malaysia

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