A market model for inflation

Nabyl Belgrade (), Eric Benhamou () and Etienne Koehler ()
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Nabyl Belgrade: CERMSEM et CDC IXIS-CM,R&D
Etienne Koehler: CERMSEM et CDC IXIS Risk

Cahiers de la Maison des Sciences Economiques from Université Panthéon-Sorbonne (Paris 1)

Abstract: The various macro econometrics models for inflation are helpless when it comes to the pricing of inflation derivatives. The only article targeting inflation option pricing, the Jarrow Yildirim model (2000), relies on non observable data. This makes the estimation of the model parameters a non trivial problem. In addition, their framework does not examine any relationship between the most liquid inflation derivatives instruments: the year to year and zero coupon swap. To fill this gap, we see how to derive a model on inflation, based on traded and liquid market instrument. Applying the same strategy as the one for a market model on interest rates, we derive no-arbitrage relationship between zero coupon and year to year swaps. We explain how to compute the convexity adjustment and what relationship the volatility surface should satisfy. Within this framework, it becomes much easier to estimate model parameters and to price inflation derivatives in a consistent way

Keywords: Inflation index; forward; zero-coupon; year-on-year; volatility cube; convexity adjustment (search for similar items in EconPapers)
JEL-codes: C59 (search for similar items in EconPapers)
Pages: 15 pages
Date: 2004-01
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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