Decomposing Real and Nominal Yield Curves

62 Pages Posted: 3 Sep 2012 Last revised: 7 Dec 2013

See all articles by Michael Abrahams

Michael Abrahams

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Tobias Adrian

International Monetary Fund

Richard K. Crump

Federal Reserve Banks - Federal Reserve Bank of New York

Emanuel Moench

Deutsche Bundesbank; Goethe University Frankfurt - Department of Money and Macroeconomics

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2012

Abstract

We present an affine term structure model for the joint pricing of real and nominal bond yields that accounts for illiquidity. Using the model to adjust breakevens for inflation and liquidity risk substantially improves inflation forecasts. Our estimates imply that the Federal Reserve’s large-scale asset purchases lowered Treasury yields primarily by reducing real term premia. Real term premia also account for the positive response of long-term real forward rates to surprise changes in the federal funds target. Applying our model to U.K. data, we find that the inflation risk premium dropped significantly when the Bank of England formally adopted an inflation target.

Keywords: TIPS, inflation expectations, affine term structure models

JEL Classification: G10, G12

Suggested Citation

Abrahams, Michael and Adrian, Tobias and Crump, Richard K. and Moench, Emanuel, Decomposing Real and Nominal Yield Curves (September 1, 2012). Midwest Finance Association 2013 Annual Meeting Paper, Available at SSRN: https://ssrn.com/abstract=2140023 or http://dx.doi.org/10.2139/ssrn.2140023

Michael Abrahams (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Tobias Adrian

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
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HOME PAGE: http://www.tobiasadrian.com

Richard K. Crump

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

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United States

Emanuel Moench

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany
+49 69 95662312 (Phone)

HOME PAGE: http://https://www.bundesbank.de/en/emanuel-moench

Goethe University Frankfurt - Department of Money and Macroeconomics ( email )

Germany

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