Swapping Headline for Core Inflation: An Asset Liability Management Approach

Nicolas Fulli-Lemaire and Ernesto Palidda

MPRA Paper from University Library of Munich, Germany

Abstract: Headline inflation in most industrialized countries, the US in particular, has been shown to be mean reverting to core inflation in the medium term, whilst at the same time the pass-through of exogenous commodity price shocks from the headline to the core has dramatically gone down as a result of a major macroeconomic paradigm change. It yields lower relative volatility for the latter and creates a drive for investing in commodities as a hedge for the spread between both inflation measures. In this paper, we argue for a risk reduction in ALM strategy in the form of a shift from targeting core rather than headline inflation for long-term hedgers while proposing an overlaying core versus headline swap to hedge the potential asset-liability gap. A market curve for core inflation could be derived from the trading of these derivatives and enable easy mark-to-market valuation of any core-linked securities, thus easing the way for future primary issues. Any supply and demand market disequilibria between long-term sellers of headline inflation and short-term sellers of core inflation could be matched by the intermediation of market makers which could price the derivative based on the cross-hedging potential of commodities.

Keywords: ALM; LDI; Long-term Investment; Inflation Hedging; Core Inflation; Commodities; Inflation Pass-through; Arbitrage Pricing; Synthetic Futures; Inflation Derivative (search for similar items in EconPapers)
JEL-codes: E31 G11 G13 Q0 (search for similar items in EconPapers)
Date: 2012-08-07, Revised 2012-11-16
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (3)

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https://mpra.ub.uni-muenchen.de/43653/1/MPRA_paper_43653.pdf revised version (application/pdf)

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