Inflation Expectations, Real Interest Rate and Risk Premiums
INFLATION EXPECTATIONS,REAL INTEREST RATE AND RISK PREMIUMS— EVIDENCE FROM BOND MARKET AND CONSUMER SURVEY DATA Dong Fu Research Department Working Paper 0705 FEDERAL RESERVE BANK OF DALLAS In‡ation Expectations, Real Interest Rate and Risk Premiums— Evidence from Bond Market and Consumer Survey Data Dong Fuy June 2007 Abstract This paper extracts information on in‡ation expectations, the real interest rate, and various risk premiums by exploring the underlying common factors among the actual in‡ation, Univer- sity of Michigan consumer survey in‡ation forecast, yields on U.S. nominal Treasury bonds, and particularly, yields on Treasury In‡ation Protected Securities (TIPS). Our …ndings suggest that a signi…cant liquidity risk premium on TIPS exists, which leads to in‡ation expectations that are generally higher than the in‡ation compensation measure at the 10-year horizon. On the other hand, the estimated expected in‡ation is mostly lower than the consumer survey in‡ation forecast at the 12-month horizon. Survey participants slowly adjust their in‡ation forecasts in response to in‡ation changes. The nominal interest rate adjustment lags in‡ation move- ments too. Our model also edges out a parsimonious seasonal AR(2) time series model in the one-step-ahead forecast of in‡ation. JEL classi…cation: E43, G12, C32 Key words: In‡ation Expectations, Treasury In‡ation Protected Securities (TIPS), Survey In‡ation Forecast, Kalman Filter I would like to thank Nathan Balke for continuous guidance and encouragement. I also gratefully acknowledge comments and suggestions from Thomas Fomby, Esfandiar Maasoumi, Mark Wynne, Tao Wu, John Duca, Jahyeong Koo, Jonathan Wright, seminar participants at the Federal Reserve Bank of Dallas, O¢ ce of the Comptroller of the Currency and SERI, participants at the LAMES 2006 and the SEA 2006 annual meeting.
[Show full text]