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

53 Pages Posted: 18 Apr 2012

See all articles by Joseph G. Haubrich

Joseph G. Haubrich

Federal Reserve Bank of Cleveland

George Pennacchi

University of Illinois

Peter H. Ritchken

Case Western Reserve University - Department of Banking & Finance

Multiple version iconThere are 2 versions of this paper

Date Written: November 11, 2008

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 Proected 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 of interest rates, infl ation expectations, asset pricing

JEL Classification: E43, G12, E52

Suggested Citation

Haubrich, Joseph G. and Pennacchi, George G. and Ritchken, Peter H., Estimating Real and Nominal Term Structures Using Treasury Yields, Inflation, Inflation Forecasts, and Inflation Swap Rates (November 11, 2008). FRB of Cleveland Working Paper No. 08-10. Available at SSRN: https://ssrn.com/abstract=2038437

Joseph G. Haubrich (Contact Author)

Federal Reserve Bank of Cleveland ( email )

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George G. Pennacchi

University of Illinois ( email )

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

Peter H. Ritchken

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

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

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