Risk-Adjusted Expectations of Inflation

25 Pages Posted: 6 Feb 2016

See all articles by Marco Casiraghi

Marco Casiraghi

Bank of Italy; International Monetary Fund (IMF) - International Capital Markets Department

Marcello Miccoli

Bank of Italy

Date Written: July 23, 2015

Abstract

We propose a new way to compute market-based risk-adjusted measures of inflation expectations. Borrowing from the finance literature, we study the ex-post excess return on inflation swap contracts – the difference between the swap rate at a given maturity and the realized inflation rate over the same horizon – which is an unbiased proxy of risk premia under the rational expectations hypothesis. The empirical results show that the risk premia on inflation swap rates at short-to-medium maturities can be predicted by macroeconomic variables that are present in agents' information set at the time the contract is signed, and that they vary counter-cyclically. This econometric analysis is then used to construct a measure of risk-adjusted inflation expectations so as to assess the role of risk premia in determining inflation swap rates. On this basis we find that the observed decline in inflation swap rates at short-to-medium maturities in 2014 was driven mainly by changes in inflation expectations.

Keywords: Monetary Policy, Inflation swap, Inflation expectations, Risk premia

JEL Classification: E52, G13

Suggested Citation

Casiraghi, Marco and Casiraghi, Marco and Miccoli, Marcello, Risk-Adjusted Expectations of Inflation (July 23, 2015). Bank of Italy Occasional Paper No. 286, Available at SSRN: https://ssrn.com/abstract=2728306 or http://dx.doi.org/10.2139/ssrn.2728306

Marco Casiraghi (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

International Monetary Fund (IMF) - International Capital Markets Department ( email )

700 19th Street NW
Washington, DC 20431
United States

Marcello Miccoli

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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