The inflation risk premium: The impact of the financial crisis

  • Alexander de Roode Alexander de Roode

This paper examines the inflation risk premium in affine term structure models. By estimating empirical distributions for the inflation risk premium using a new Bayesian methodology,we find a wide range of likely estimates. Credibility intervals for 5 year maturity range from about -95 to 88 basis points in the UK and -4 to 119 basis points in the US during the period of 2004-2012. Our results show that affine term structure models are unable to capture the inflation risk premium accurately. To that end, we use a Bayesian methodology to show how the financial crisis 2008 impacts the uncertainty regarding inflation risk premium. We find asubstantial upward shift in the inflation risk premium in the UK while an downward shift in the US. In particular, credibility intervals shift to -105 to 150 in the UK and -50 to 92 basispoints in the US.

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