Extraction of financial market expectations about inflation and interest rates from a liquid market

Ricardo Gimeno and Jose Manuel Marqués Sevillano ()

No 906, Working Papers from Banco de España

Abstract: In this paper we propose an affine model that uses as observed factors the Nelson and Siegel (NS) components summarising the term structure of interest rates. By doing so, we are able to reformulate the Diebold and Li (2006) approach to forecast the yield curve in a way that allows us to incorporate a non-arbitrage opportunities condition and risk aversion into the model. These conditions seem to improve the forecasting ability of the term structure components and provide us with an estimation of the risk premia. Our approach is somewhat equivalent to the recent contribution of Christiensen, Diebold and Rudebusch (2008). However, not only does it seem to be more intuitive and far easier to estimate, it also improves that model in terms of fitting and forecasting properties. Moreover, with this framework it is possible to incorporate directly the inflation rate as an additional factor without reducing the forecasting ability of the model. The augmented model produces an estimation of market expectations about inflation free of liquidity, counterparty and term premia. We provide a comparison of the properties of this indicator with others usually employed to proxy the inflation expectations, such as the break-even rate, inflation swaps and professional surveys.

Keywords: Interest Rate Forecast; Inflation Expectations; Affine Model; Diebold and Li (search for similar items in EconPapers)
JEL-codes: C53 E43 E44 G12 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2009-04
New Economics Papers: this item is included in nep-cba, nep-ecm, nep-fmk, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

Downloads: (external link)
http://www.bde.es/f/webbde/SES/Secciones/Publicaci ... o/09/Fic/dt0906e.pdf First version, April 2009 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bde:wpaper:0906

Access Statistics for this paper

More papers in Working Papers from Banco de España Contact information at EDIRC.
Bibliographic data for series maintained by Ángel Rodríguez. Electronic Dissemination of Information Unit. Research Department. Banco de España ().