Inflation Ambiguity and the Term Structure of U.S. Government Bonds
35 Pages Posted: 14 Nov 2008 Last revised: 29 Aug 2012
Date Written: November 16, 2011
Variations in trend inflation are the main driver for variations in the nominal yield curve. According to empirical data, investors observe a set of empirical models that could all have generated the time-series for trend inflation. This set has been large and volatile during the 1970s and early 1980s and small during the 1990s. I show that log utility together with model uncertainty about trend inflation can explain the term premium in U.S. Government bonds. The equilibrium has two inflation premiums, an inflation risk premium and an inflation ambiguity premium.
Keywords: Term premium, inflation ambiguity premium, model uncertainty, yield curve, multiple prior
JEL Classification: C13, C32, E43, E44, G12
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