Retrieving Inflation Expectations And Risk Premia Effects From The Term Structure Of Interest Rates

This paper suggests an empirically attractive Gaussian dynamic term structure model to retrieve estimates of real interest rates and in፟lation expectations from the nominal term structure of interest rates which are net of in፟lation risk premium effects. The paper shows that this model is consistent with the data and that time-variation of inflፚtion risk premium and real interest rates can explain the puzzling behavior of the spread between long and short-term nominal interest rates to forecast changes in in፟lation rates, especially over short-term horizons. The estimates of in፟lation risk premium effects retrieved by the model tend to be negative and signiጿicant, which implies that investors in the bond market require less compensation for holding nominal bonds compared to in፟lation-indexed bonds. This is more evident during the recent fiijnancial crisis.