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Inflation Derivatives Under Inflation Target Regimes

37 Pages Posted: 19 Aug 2008 Last revised: 27 Apr 2012

Mordecai Avriel

Technion-Israel Institute of Technology; Bank Hapoalim

Jens Hilscher

University of California, Davis

Alon Raviv

Bar-Ilan University - Graduate School of Business Administration

Date Written: April 26, 2012

Abstract

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

Avriel, Mordecai and Hilscher, Jens and Raviv, Alon, Inflation Derivatives Under Inflation Target Regimes (April 26, 2012). Available at SSRN: https://ssrn.com/abstract=1232922 or http://dx.doi.org/10.2139/ssrn.1232922

Mordecai Avriel

Bank Hapoalim ( email )

Haifa
Israel

Technion-Israel Institute of Technology ( email )

Technion City
Haifa 32000, Haifa 32000
Israel

Jens Hilscher

University of California, Davis ( email )

One Shields Avenue
Davis, CA 95616
United States

Alon Raviv (Contact Author)

Bar-Ilan University - Graduate School of Business Administration ( email )

The Graduate School of Business Administration
Ana and Max Web st
Ramat Gan
Israel

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