Swapping from Headline to Core Inflation and Commodity Hedging

Insurance Risk - Risk, Oct. 2014

European Business Research Conference Proceedings - Rome IT, 2012

Southwestern Finance Association 2013 Annual Meeting Paper - Albuquerque NM, 2013

AIDEA 2013 Banking & Finance Annual Conference Paper - Lecce IT, 2013

34 Pages Posted: 8 Aug 2012 Last revised: 19 Oct 2014

See all articles by Nicolas Fulli-Lemaire

Nicolas Fulli-Lemaire

Oliver Wyman SA

Ernesto Palidda

Crédit Agricole Corporate and Investment Bank - Credit Agricole Asset Management

Date Written: September 16, 2013

Abstract

Headline inflation in most industrialized countries, the US in particular, has been shown to be mean reverting to core inflation in the medium term, whilst at the same time the pass-through of exogenous commodity price shocks from the headline to the core has dramatically gone down as a result of a major macroeconomic paradigm change. It yields lower relative volatility for the latter and creates a drive for investing in commodities as a hedge for the spread between both inflation measures. In this paper, we argue for a risk reduction in ALM strategy in the form of a shift from targeting core rather than headline inflation for long-term hedgers while proposing an overlaying core versus headline swap to hedge the potential asset-liability gap. A market curve for core inflation could be derived from the trading of these derivatives and enable easy mark-to-market valuation of any core-linked securities, thus easing the way for future primary issues. Any supply and demand market disequilibria between sellers of headline inflation and sellers of core inflation could be matched by the intermediation of market makers which could price the derivative based on the cross-hedging potential of commodities.

Keywords: ALM, LDI, Long-term Investment, Inflation Hedging, Core Inflation, Commodities, Inflation Pass-through, Arbitrage Pricing, Synthetic Futures, Inflation Derivative, Monte-Carlo

JEL Classification: C58, C63, E31, F01, G11, G12, G13, G13, G23, G24, Q02

Suggested Citation

Fulli-Lemaire, Nicolas and Palidda, Ernesto, Swapping from Headline to Core Inflation and Commodity Hedging (September 16, 2013). Insurance Risk - Risk, Oct. 2014; European Business Research Conference Proceedings - Rome IT, 2012; Southwestern Finance Association 2013 Annual Meeting Paper - Albuquerque NM, 2013; AIDEA 2013 Banking & Finance Annual Conference Paper - Lecce IT, 2013. Available at SSRN: https://ssrn.com/abstract=2125962 or http://dx.doi.org/10.2139/ssrn.2125962

Nicolas Fulli-Lemaire (Contact Author)

Oliver Wyman SA ( email )

1 rue Euler
Paris, 75008
France

Ernesto Palidda

Crédit Agricole Corporate and Investment Bank - Credit Agricole Asset Management ( email )

9, quai du Président Paul Doumer
92920 Paris La Défense Cedex, 75015
France

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