Inflation Derivatives Under Inflation Target Regimes
37 Pages Posted: 19 Aug 2008 Last revised: 27 Apr 2012
Date Written: April 26, 2012
Inflation targeting -- the central bank practice of attempting to keep inflation levels within fixed bounds around a quantitative target -- has been adopted by more than twenty economies. Such practice has an important impact on the stochastic nature of inflation and, consequently, on the pricing of inflation derivatives. We develop a flexible model of inflation targeting in which the central bank's intervention to steer inflation towards the target depends on past deviations and the policymaker's ability or will to enforce the target. We use our model to price inflation derivatives and demonstrate the impact of inflation targeting on derivative pricing.
Keywords: inflation derivatives, inflation targeting, target zones, option pricing
JEL Classification: G12, G13
Suggested Citation: Suggested Citation