Inflation co-movement across countries in multi-maturity term structure: An arbitrage-free approach

Research, Book English OPEN
Chen, Shi ; Härdle, Wolfgang Karl ; Wang, Weining (2015)
  • Publisher: SFB 649, Economic Risk Berlin
  • Subject: E31 | arbitrage free | inflation expectation dynamics | E43 | G12 | yield curve modelling | HG | inflation risk
    • ddc: ddc:330

Inflation expectation is acknowledged to be an important indicator for policy makers and financial investors. To capture a more accurate real-time estimate of inflation expectation on the basis of financial markets, we propose an arbitrage-free model across different countries in a multi-maturity term structure, where we first estimate inflation expectation by modelling the nominal and inflation-indexed bond yields jointly for each country. The Nelson-Siegel model is popular in fitting the term structure of government bond yields, the arbitrage-free model we proposed is the extension of the arbitrage-free dynamic Nelson-Siegel model proposed by Christensen, Diebold and Rudebusch (2011). We discover that the extracted common trend for inflation expectation is an important driver for each country of interest. Moreover, the model will lead to an improved forecast in a benchmark level of inflation and will provide good implications for financial markets.
  • References (5)

    Christensen, J. H., Diebold, F. X. and Rudebusch, G. D. (2011). The ane arbitrage-free class of nelsonsiegel term structure models, Journal of Econometrics 164(1): 420.

    Christensen, J. H., Lopez, J. A. and Rudebusch, G. D. (2010). Ination expectations and risk premiums in an arbitrage-free model of nominal and real bond yields, Journal of Money, Credit and Banking 42(1): 143178.

    Diebold, F. X. and Li, C. (2006). Forecasting the term structure of government bond yields, Journal of Econometrics 130(2): 337364.

    Diebold, F. X., Li, C. and Yue, V. Z. (2008). Global yield curve dynamics and interactions: a dynamic nelsonsiegel approach, Journal of Econometrics 146(2): 351363.

    Diebold, F. X., Rudebusch, G. D. and Aruoba, S. B. (2006). The macroeconomy and the yield curve: a dynamic latent factor approach, Journal of Econometrics 131(1): 309 338.

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