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Estimating Real and Nominal Term Structures Using Treasury Yields, Inflation, Inflation Forecasts, and Inflation Swap Rates

52 Pages Posted: 17 Mar 2009  

Joseph G. Haubrich

Federal Reserve Bank of Cleveland

Peter H. Ritchken

Case Western Reserve University - Department of Banking & Finance

George Pennacchi

University of Illinois

Multiple version iconThere are 2 versions of this paper

Date Written: March, 16 2009

Abstract

This paper develops and estimates an equilibrium model of the term structures of nominal and real interest rates. The term structures are driven by state variables that include the short term real interest rate, expected inflation, a factor that models the changing level to which inflation is expected to revert, as well as four volatility factors that follow GARCH processes. We derive analytical solutions for the prices of nominal bonds, inflation-indexed bonds that have an indexation lag, the term structure of expected inflation, and inflation swap rates. The model parameters are estimated using data on nominal Treasury yields, survey forecasts of inflation, and inflation swap rates. We find that allowing for GARCH effects is particularly important for real interest rate and expected inflation processes, but that long-horizon real and inflation risk premia are relatively stable. Comparing our model prices of inflation-indexed bonds to those of Treasury Inflation Protected Securities (TIPS) suggests that TIPS were underpriced prior to 2004 but subsequently were valued fairly. We find that unexpected increases in both short run and longer run inflation implied by our model have a negative impact on stock market returns.

Keywords: Term Structure, Inflation-Indexed Securities

JEL Classification: E43, G12

Suggested Citation

Haubrich, Joseph G. and Ritchken, Peter H. and Pennacchi, George, Estimating Real and Nominal Term Structures Using Treasury Yields, Inflation, Inflation Forecasts, and Inflation Swap Rates (March, 16 2009). Available at SSRN: https://ssrn.com/abstract=1361219 or http://dx.doi.org/10.2139/ssrn.1361219

Joseph G. Haubrich

Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States
216-579-2802 (Phone)
216-579-3050 (Fax)

Peter H. Ritchken

Case Western Reserve University - Department of Banking & Finance ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States
216-368-3849 (Phone)
216-368-4776 (Fax)

George G. Pennacchi (Contact Author)

University of Illinois ( email )

4041 BIF, Box 25
515 East Gregory Drive
Champaign, IL 61820
United States
217-244-0952 (Phone)

HOME PAGE: http://www.business.illinois.edu/gpennacc/

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