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Term, Inflation, and Foreign Exchange Risk Premia

Author : Lars E. O. Svensson

Publisher :

Page : 52 pages

File Size : 41,46 MB

Release : 1993

Category : Inflation (Finance)

ISBN :

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Book Description

The paper reviews the theoretical foundations of the use of forward interest rates to infer expected future rates of interest, inflation, currency depreciation and inflation differentials. Forward rates are related to these expected future variables via combinations of term, inflation and foreign exchange risk premia. A unified derivation, discussion and comparison of these premia is provided under both general and specific assumptions, as well as some comments on empirical estimation.



Using Affine Models of the Term Structure to Estimate Risk Premia

Author : Nikolaos Panigirtzoglou

Publisher :

Page : 19 pages

File Size : 23,14 MB

Release : 2005

Category :

ISBN :

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Book Description

This paper uses affine models of the term structure to provide historical estimates of risk premia. The foreign exchange and inflation risk premia can be modelled in the same way since the price level can be thought of as an exchange rate that transforms real prices to nominal prices. Affine models with three latent factors of the Cox, Ingersoll and Ross (1985) type are used, with a common factor between the two pricing kernels (state price vectors) to account for interdependence. In the case of foreign exchange risk premium two factors are used to model the domestic pricing kernel and two factors to model the foreign pricing kernel with a common factor between them. This specification can account for the forward premium anomaly, the tendency for high interest rate currencies to appreciate, which contradicts uncovered interest rate parity. In the case of inflation risk premium two factors are used to model the real pricing kernel and two factors to model the nominal pricing kernel with a common factor between them. The model distinguishes between expected and realised variables and therefore allows the estimation of expectational errors. The model also allows for time-varying market prices of risk and time-varying correlations between the two pricing kernels or between each of the pricing kernels and the foreign exchange rate or the price level. Another contribution, which has been ignored in the previous literature, is that the model is estimated using both bond yields and realised price level or foreign exchange rate changes. Fitting the later is necessary for the model to produce realistic patterns for the price level or foreign exchange rate changes. The results show that the foreign exchange risk premium fell substantially after 96, which is consistent with the large appreciation of sterling. Expectational errors were very large for the whole of the period studied, that is, from 93 to 99. Inflation risk premium was about 100 basis points for most of the period 87 to 97, but fell substantially since Bank independence in March 97, which may be the result of a higher credibility to the new UK monetary policy institutional framework. Inflation expectational errors also became smaller after the adoption of inflation targeting in UK in January 93.



Inflation Expectations

Author : Peter J. N. Sinclair

Publisher : Routledge

Page : 402 pages

File Size : 14,20 MB

Release : 2009-12-16

Category : Business & Economics

ISBN : 1135179778

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Book Description

Inflation is regarded by the many as a menace that damages business and can only make life worse for households. Keeping it low depends critically on ensuring that firms and workers expect it to be low. So expectations of inflation are a key influence on national economic welfare. This collection pulls together a galaxy of world experts (including Roy Batchelor, Richard Curtin and Staffan Linden) on inflation expectations to debate different aspects of the issues involved. The main focus of the volume is on likely inflation developments. A number of factors have led practitioners and academic observers of monetary policy to place increasing emphasis recently on inflation expectations. One is the spread of inflation targeting, invented in New Zealand over 15 years ago, but now encompassing many important economies including Brazil, Canada, Israel and Great Britain. Even more significantly, the European Central Bank, the Bank of Japan and the United States Federal Bank are the leading members of another group of monetary institutions all considering or implementing moves in the same direction. A second is the large reduction in actual inflation that has been observed in most countries over the past decade or so. These considerations underscore the critical – and largely underrecognized - importance of inflation expectations. They emphasize the importance of the issues, and the great need for a volume that offers a clear, systematic treatment of them. This book, under the steely editorship of Peter Sinclair, should prove very important for policy makers and monetary economists alike.



Term-Structure of Consumption Risk Premia in the Cross Section of Currency Returns

Author : Irina Zviadadze

Publisher :

Page : 69 pages

File Size : 12,60 MB

Release : 2016

Category :

ISBN :

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Book Description

I quantify the risk-return relationship in the foreign-exchange (FX) market across different countries and investment horizons by focusing on the role of multiple sources of consumption risk. I estimate a flexible structural model of the joint dynamics of US aggregate consumption, inflation, nominal yield, and stochastic variance with cross-equation restrictions implied by recursive preferences. I identify four sources of consumption risk: short-run, long-run, inflation, and variance shocks. The long-run consumption risk plays a prominent role in the FX market: it contributes to the spread in returns between high and low interest rate currencies across multiple investment horizons from one to five quarters. The short-run consumption risk affects currencies only at the quarterly horizon, where it explains 40% of the spread. The difference in returns between high and low yield currencies disappears for horizons longer than four quarters.



Inflation Risk Premia in the Term Structure of Interest Rates

Author : Peter Hördahl

Publisher :

Page : 56 pages

File Size : 21,3 MB

Release : 2007

Category : Banks and banking, Central

ISBN :

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Book Description

"This paper estimates the size and dynamics of inflation risk premia in the euro area, based on a joint model of macroeconomic and term structure dynamics. Information from both nominal and index-linked yields is used in the empirical analysis. Our results indicate that term premia in the euro area yield curve reflect predominantly real risks, i.e. risks which affect the returns on both nominal and index-linked bonds. On average, inflation risk premia were negligible during the EMU period but occasionally subject to statistically significant fluctuations in 2004-2006. Movements in the raw break-even rate appear to have mostly reflected such variations in inflation risk premia, while long-term inflation expectations have remained remarkably anchored from 1999 to date." - - Abstract.



Inflation Targeting and Country Risk

Author : Mr.Armand Fouejieu

Publisher : International Monetary Fund

Page : 30 pages

File Size : 20,90 MB

Release : 2013-01-23

Category : Business & Economics

ISBN : 1475554710

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Book Description

The sovereign debt crisis in Europe has highlighted the role of country risk premia as a link between countries’ fiscal and external balances, financial conditions and monetary policy. The purpose of this paper is to estimate how adoption of inflation targeting (IT) affects spreads. It is hypothesized that country risk premia for IT countries (especially among emerging market economies) may be lower than for other countries owing to greater policy predictability and more stable long-term inflation. The findings suggest that IT reduces the risk premium, both through adoption of the IT regime, and through the observed track record in stabilizing inflation.







Inflation, Fisher Equation, and the Term Structure of Inflation Risk Premia

Author : Ren-Raw Chen

Publisher :

Page : 50 pages

File Size : 42,46 MB

Release : 2010

Category :

ISBN :

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Book Description

In this paper, we study inflation risk and the term structure of inflation risk premia in the U.S. nominal interest rates through the Treasury Inflation Protection Securities (TIPS) and an analytical two-factor Cox-Ingersoll-Ross (CIR) model with correlated real rate and inflation. The analytical formula facilitates the estimation of the model parameters and improves the accuracy of the valuation of nominal rates and TIPS, and especially enables us to estimate the term structure of inflation risk premia.We use the two-factor model to evaluate the inflation-index bonds and study the relationship between the real rate and the expected inflation rate implied by the nominal Constant Maturity Treasury (CMT) rates for the period of January 1998 through December 2004. We use the Unscented Kalman Filter (UKF) to estimate the model and the inflation risk premium. The empirical evidence indicates that the expected inflation rate, as opposed to those derived from the consumer price indexes, is very stable and the inflation risk premia demonstrate a steep term structure.