Oil Price, Bond Return, and Breakeven Inflation

58 Pages Posted: 27 Jan 2018 Last revised: 21 Feb 2019

See all articles by Haibo Jiang

Haibo Jiang

School of Management, Université du Québec à Montréal (UQAM); Tulane University - A.B. Freeman School of Business

Date Written: February 11, 2019

Abstract

Compared with stocks, bonds are more directly affected by fluctuations in oil prices through the expected inflation component in nominal bond yields. Surprisingly, prior literature finds little predictive power of oil price changes on bond excess returns. This finding is counter intuitive, especially given the strong predictive relationship between oil price changes and equity risk premium. Using oil supply, global demand, and oil-specific demand shocks, estimated from a structural VAR model of oil price changes, this paper provides new empirical evidence - the oil price changes driven by global demand shocks predict negative real bond risk premium and positive inflation risk premium. Since these two effects offset each other, we observe insignificant effect on the bond risk premium. A two-sector New Keynesian model shows theoretically that real bond yield, breakeven inflation, and nominal bond yield respond differently to oil supply and demand shocks.

Keywords: Oil prices, bond returns, breakeven inflation, Treasury Inflation Protected Securities (TIPS), oil supply shock, global demand shock, and oil-specific shock

JEL Classification: E31, E43, E44, G12, G14, Q41, Q43

Suggested Citation

Jiang, Haibo, Oil Price, Bond Return, and Breakeven Inflation (February 11, 2019). Available at SSRN: https://ssrn.com/abstract=3105095 or http://dx.doi.org/10.2139/ssrn.3105095

Haibo Jiang (Contact Author)

School of Management, Université du Québec à Montréal (UQAM) ( email )

315 St. Catherine Street East
Montreal, Quebec H2X 3X2
Canada

Tulane University - A.B. Freeman School of Business ( email )

A.B. Freeman School of Business
7 McAlister Drive
New Orleans, LA 70118
United States
504-314-2492 (Phone)

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