Inflation narratives and risk premia

Luís Fonseca, Giulia Martorana, Fabian Schupp and Giovanni Trebbi

No 3288, Working Paper Series from European Central Bank

Abstract: Theory suggests inflation risk premia are positive when supply shocks are expected to dominate demand shocks and negative otherwise. We measure these beliefs using demand and supply narratives derived from inflation news via Causality Extraction, which identifies causal relations between inflation and its drivers. Using narrative extracted from inflation news from the Financial Times for the Euro Area and the Wall Street Journal for the US, our key variable, NetDemand, measures the difference in articles attributing inflation to demand versus supply factors. Consistent with asset pricing theory, inflation risk premia are inversely related to NetDemand across maturities in both regions. This relationship holds even after controlling for the composite PMI and VIX, strengthens with risk aversion in the US and inflation volatility in the Euro Area, and is not subsumed by other measures of demand and supply contributions to inflation, views of professional forecasters, or narratives obtained from LLMs. JEL Classification: C53, E44, G12

Keywords: demand and supply; natural language processing; news media (search for similar items in EconPapers)
Date: 2026-09
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20263288

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