The Term Structure of Real Rates and Expected Inflation

67 Pages Posted: 14 Sep 2004

See all articles by Andrew Ang

Andrew Ang

BlackRock, Inc

Geert Bekaert

Columbia Business School - Finance and Economics

Multiple version iconThere are 3 versions of this paper

Date Written: August 2004

Abstract

Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, time-varying prices of risk and inflation to identify these components of the nominal yield curve. We find that the unconditional real rate curve is fairly flat at 1.44%, but slightly humped. In one regime, the real term structure is steeply downward sloping. Real rates (nominal rates) are pro-cyclical (counter-cyclical) and inflation is negatively correlated with real rates. An inflation risk premium that increases with the horizon fully accounts for the generally upward sloping nominal term structure. We find that expected inflation drives about 80% of the variation of nominal yields at both short and long maturities, but during normal times, all of the variation of nominal term spreads is due to expected inflation and inflation risk.

Suggested Citation

Ang, Andrew and Bekaert, Geert, The Term Structure of Real Rates and Expected Inflation (August 2004). CEPR Discussion Paper No. 4518. Available at SSRN: https://ssrn.com/abstract=590701

Andrew Ang (Contact Author)

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

Geert Bekaert

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

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