Price Discovery on Traded Inflation Expectations: Does the Financial Crisis Matter?

56 Pages Posted: 8 Jun 2016

Date Written: 2009

Abstract

We analyze contributions of different markets to price discovery on traded inflation expectations and how it changed during the financial crisis. The quicker information is processed on one market and the less one market is disrupted by the financial crisis the more valuable is its information for central banks and market participants. We use a new high frequency data set on inflation-indexed and nominal government bonds as well as inflation swaps to calculate information shares of break-even inflation rates in the euro area and the US. For maturities up to 5 years new information comes from both the swap and the bond markets. For longer maturities the swap market provides less and less information in the euro area. In the US where the market volume of inflation-linked bonds is large the bond market dominates the price discovery process for all maturities. The severe financial crisis that spread out in Autumn 2008 drove a wedge between bond and swap break-even inflation rates in both currencies. Price discovery ceased to take place on the swap market. Disruptions coming from the short-end of the market even separated price formation on both segments for maturities of up to 6 years in the US. Against the backdrop of the most severe financial crisis in decades contributions to price formation concentrated a lot more on the presumably safest financial instrument: government bonds.

Keywords: Inflation-linked bonds, inflation swaps, price discovery, financial crisis

JEL Classification: E43, F37, G15

Suggested Citation

Schulz, Alexander and Stapf, Jelena, Price Discovery on Traded Inflation Expectations: Does the Financial Crisis Matter? (2009). Bundesbank Series 1 Discussion Paper No. 2009,25. Available at SSRN: https://ssrn.com/abstract=2785354

Alexander Schulz (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Jelena Stapf

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Strasse 14
60431 Frankfurt am Main
Germany

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