50 Pages Posted: 29 Feb 2012
Date Written: January 26, 2012
Estimates of the real term structure for the euro area implied by French index-linked bonds are obtained by means of a smoothing spline methodology. The real term structure allows computation of the constant-maturity inflation compensation, which is compared with the surveyed inflation expectations in order to obtain a rough measure of the inflation risk premium. The comparison between the inflation compensation and the inflation swap shows that the two variables are closely interlinked but differently affected by illiquidity during periods of stress. The methodology used in this paper is quite effective at capturing the general shape of the real term structure while smoothing through idiosyncratic variations in the yields of index-linked bonds. Real interest rates tend to be quite stable at longer horizons and the average 10-year real rate from 2002 to 2009 is close to 2 percent. Furthermore, evidence is found that inflation compensation was held down in the period 2008-09 by an increase in the liquidity premium of index-linked bonds.
Keywords: index-linked bond, real term structure, inflation compensation, inflation risk premium, smoothing spline
JEL Classification: C02, G10, G12
Suggested Citation: Suggested Citation
Pericoli, Marcello, Real Term Structure and Inflation Compensation in the Euro Area (January 26, 2012). Bank of Italy Temi di Discussione (Working Paper) No. 841. Available at SSRN: https://ssrn.com/abstract=2012457 or http://dx.doi.org/10.2139/ssrn.2012457