Abstract

http://ssrn.com/abstract=2028391
 
 

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Disagreement about Inflation and the Yield Curve


Paul Ehling


BI - Norwegian Business School

Michael F. Gallmeyer


University of Virginia (UVA) - McIntire School of Commerce

Christian Heyerdahl-Larsen


London Business School - Department of Finance

Philipp K. Illeditsch


University of Pennsylvania - Finance Department

February 28, 2013


Abstract:     
We study how differences in beliefs about expected inflation impact real and nominal yield curves in a frictionless economy. Inflation disagreement induces a spillover effect to the real side of the economy with a strong impact on the real yield curve. When investors have a coefficient of relative risk aversion greater than one, real yields across all maturities rise as disagreement increases. Real yield volatilities also rise with disagreement. Using the feature that nominal bond prices can be computed from weighted-averages of quadratic Gaussian yield curves, we explore three properties of the model numerically. First, both real and nominal yield curves are strongly impacted by inflation disagreement relative to a full information economy. Second, increased inflation disagreement drives nominal yields and nominal yield volatilities higher at all maturities. Third, expected inflation beliefs impact real yields. Empirical support for our predictions on yield levels and yield volatilities is provided.

Number of Pages in PDF File: 49

Keywords: Disagreement about expected inflation, feedback effect, real and nominal yields

JEL Classification: D51, E43, E52, G12

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Date posted: March 26, 2012 ; Last revised: March 2, 2013

Suggested Citation

Ehling, Paul and Gallmeyer, Michael F. and Heyerdahl-Larsen, Christian and Illeditsch, Philipp K., Disagreement about Inflation and the Yield Curve (February 28, 2013). Available at SSRN: http://ssrn.com/abstract=2028391 or http://dx.doi.org/10.2139/ssrn.2028391

Contact Information

Paul Ehling
BI - Norwegian Business School ( email )
N-0442 Oslo
Norway
+47 46410505 (Phone)
Michael F. Gallmeyer (Contact Author)
University of Virginia (UVA) - McIntire School of Commerce ( email )
P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-243-4043 (Phone)
434-924-7074 (Fax)
HOME PAGE: http://www.commerce.virginia.edu/faculty_research/facultydirectory/Pages/Gallmeyer.aspx
Christian Heyerdahl-Larsen
London Business School - Department of Finance ( email )
Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
Philipp K. Illeditsch
University of Pennsylvania - Finance Department ( email )
The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-3477 (Phone)

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