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The Term Structure of Real Rates and Expected Inflation

Andrew Ang () and Geert Bekaert ()

No 4518, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, time-varying prices of risk and inflation to identify these components of the nominal yield curve. We find that the unconditional real rate curve is fairly flat at 1.44%, but slightly humped. In one regime, the real term structure is steeply downward sloping. Real rates (nominal rates) are pro-cyclical (counter-cyclical) and inflation is negatively correlated with real rates. An inflation risk premium that increases with the horizon fully accounts for the generally upward sloping nominal term structure. We find that expected inflation drives about 80% of the variation of nominal yields at both short and long maturities, but during normal times, all of the variation of nominal term spreads is due to expected inflation and inflation risk.

New Economics Papers: this item is included in nep-mac and nep-mon
Date: 2004-08
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Journal Article: The Term Structure of Real Rates and Expected Inflation (2008) Downloads
Working Paper: The Term Structure of Real Rates and Expected Inflation (2007) Downloads
Journal Article: The term structure of real rates and expected inflation (2004) Downloads
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