A Joint Model of Nominal and Real Yield Curves

Daniela Kubudi and José Vicente

No 452, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: In this paper we propose a joint model of the nominal and real yield curves. The model is arbitrage free and embodies incompleteness between the nominal and real bond markets. We estimate the model using the Kalman filter with Brazilian data. First we consider that only the yields are observed with errors. Although the model fits these yields well, it presents poor inflation forecasting performance. Then, besides nominal and real yields, we estimate the model assuming that one-year ahead survey-based inflation forecasting is also observed with errors. The results show that the model using survey information does a much better inflation forecasting job. In addition, using the model estimated with survey inflation data, we show that monetary policy has significant effects on the inflation expectation and risk premium.

Date: 2016-12
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