Munich Personal RePEc Archive

Inflation expectations derived from a portfolio model

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

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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.

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