The Term Structure and Inflation Uncertainty

39 Pages Posted: 21 Dec 2016

See all articles by Tomas Breach

Tomas Breach

Federal Reserve Bank of Chicago

Stefania D'Amico

Federal Reserve Bank of Chicago

Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management; Asia School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: December 13, 2016

Abstract

This paper develops and estimates a Quadratic-Gaussia model of the U.S. term structure that can accommodate the rich dynamics of inflation risk premia over the 1983-2013 period by allowing for time-varying market prices of inflation risk and incorporating survey information on inflation uncertainty in the estimation. The model captures changes in premia over very diverse periods, from the inflation scare episodes of the 1980s, when perceived inflation uncertainty was high, to the more recent episodes of negative premia, when perceived inflation uncertainty has been considerably smaller. A decomposition of the nominal ten-year yield suggests a decline in the estimated inflation risk premium of 1.7 percentage points from the early 1980s to mid-1990s. Subsequently, its predicted value has fluctuated around zero and turned negative at times, reaching its lowest values (about -0.6 percentage points) before the latest financial crisis, in 2005-2007, and during the subsequent weak recovery, in 2010-2012. The models ability to generate sensible estimates of the inflation risk premium has important implications for the other components of the nominal yield: expected real rates, expected inflation, and real risk premia.

Keywords: Quadratic-Gaussian Term Structure Models, in‡Ation Risk Premium, Survey Forecasts, Hidden Factors

JEL Classification: G12, E43, E44, C58

Suggested Citation

Breach, Tomas and D'Amico, Stefania and Orphanides, Athanasios, The Term Structure and Inflation Uncertainty (December 13, 2016). MIT Sloan Research Paper No. 5182-16, Available at SSRN: https://ssrn.com/abstract=2888104 or http://dx.doi.org/10.2139/ssrn.2888104

Tomas Breach

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Stefania D'Amico

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Athanasios Orphanides (Contact Author)

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

100 Main Street
E62-416
Cambridge, MA 02142
United States

HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=54058

Asia School of Business ( email )

Jalan Kuching, Kuala Lumpur, Wilayah Persekutuan K
Kuala Lumpur, MA
Malaysia

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
125
Abstract Views
982
rank
176,965
PlumX Metrics