Inflation-Indexed Bonds and the Expectations Hypothesis

Carolin Pflueger and Luis Viceira ()

Annual Review of Financial Economics, 2011, vol. 3, issue 1, 139-158

Abstract: This review empirically analyzes the expectations hypothesis (EH) in inflation-indexed (or real) bonds and in nominal bonds in the United States and in the United Kingdom. We strongly reject the EH in inflation-indexed bonds, and also confirm and update the existing evidence rejecting the EH in nominal bonds. This rejection implies that the risk premium on both real and nominal bonds varies predictably over time. We also find strong evidence that the spread between the nominal and the real bond risk premium, or the breakeven inflation risk premium, also varies over time. We argue that the time variation in real bond risk premia most likely reflects both a changing real interest rate risk premium and a changing liquidity risk premium, and that the variability in the nominal bond risk premia reflects a changing inflation risk premium. We estimate significant time series variability in the magnitude and sign of bond risk premia.

Keywords: TIPS; breakeven inflation; return predictability; bond risk premia (search for similar items in EconPapers)
JEL-codes: E4 G12 (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (21)

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