Disagreement about Inflation and the Yield Curve
BI - Norwegian Business School
Michael F. Gallmeyer
University of Virginia (UVA) - McIntire School of Commerce
London Business School - Department of Finance
Philipp K. Illeditsch
University of Pennsylvania - Finance Department
September 1, 2015
We show theoretically that inflation disagreement drives a wedge between real and nominal yields and raises their levels and volatilities. We demonstrate empirically that an inflation disagreement increase of one standard deviation raises real and nominal yields and their volatilities, break-even inflation, and the inflation risk premium by at least 30% of their respective standard deviations. Inflation disagreement is positively related to consumers’ cross-sectional consumption growth volatility and trading in bonds, interest rate futures, and inflation swaps. Calibrating the model to disagreement, inflation, and yield data reproduces the economically significant impact of inflation disagreement on real and nominal yield curves.
Number of Pages in PDF File: 59
Keywords: Inflation disagreement, relative entropy, real and nominal yields, yield volatilities, break-even inflation, inflation risk premium, cross-sectional consumption growth volatility, trading on inflation
JEL Classification: D51, E43, E52, G12
Date posted: March 26, 2012 ; Last revised: September 9, 2015
© 2015 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo1 in 0.625 seconds