Short-Dated Term Premia and the Level of Inflation

Richard Crump, Charles Smith and Peter Van Tassel

No 20220928, Liberty Street Economics from Federal Reserve Bank of New York

Abstract: Since the advent of derivatives trading on short-term interest rates in the 1980s, financial commentators have often interpreted market prices as directly reflecting the expected path of future interest rates. However, market prices generally embed risk premia (or “term premia” in reference to measures of risk premia over different horizons) reflecting the compensation required to bear the risk of the asset. When term premia are large in magnitude, derivatives prices may differ substantially from investor expectations of future rates. In this post, we assess whether term premia have increased with the recent rise in inflation, given the historically positive relationship between the two series, and what this means for the interpretation of derivatives prices.

Keywords: term premia; inflation; monetary policy expectations; Federal Open Market Committee (FOMC) (search for similar items in EconPapers)
JEL-codes: E52 G1 (search for similar items in EconPapers)
Date: 2022-09-28
New Economics Papers: this item is included in nep-cba and nep-mon
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