Stochastic Inflation and the Term Structure of Interest Rates: a Simple Diffusion Model

Cristiano Baldassari, Massimiliano Meschini and Paola Nascenzi

Journal of Finance and Investment Analysis, 2024, vol. 13, issue 4, 2

Abstract: The present paper addresses the problem of valuing contingent claims on the term structure in asingle good economy under uncertain inflation. In the context of arbitrage-free valuation, a simple diffusion model for pricing inflation-indexed securities is proposed. A martingale characterization of nominal and real prices is given and a stochastic generalization of the Fisher equation is provided. An example of two-factor model which can be used to value inflation-linked securities in practical applications, is also discussed. JEL classification numbers: G00, G10, G30. Keywords: Term structure of interest rates, Fisher equation, HJM-methodology, Inflation-linked securities.

Date: 2024
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