Inflation expectations derived from a portfolio model

Covarrubias, Enrique and Hernández-del-Valle, Gerardo (2016): Inflation expectations derived from a portfolio model.

Abstract

This paper proposes a new methodology for extracting inflation expectations from financial markets. For this purpose, a synthetic financial asset is built whose returns are matched with the inflation rate by construction. The methodology estimates the implicit return expected by the market on this asset through a portfolio valuation approach; in other words, implicit inflation expectations are obtained. This approach clarifies the mechanisms behind a negative risk premium: an inflation-linked bond is attractive to an investor when high inflation is expected or when generalized low returns are observed; in both cases, a yield below expected returns is observed.

• Item Type: MPRA Paper
• Language: English
• Keywords: Inflation expectations; bond markets; breakeven.
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates

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