#09-02
Inflation Expectations and Risk Premiums in an Arbitrage-Free Model of Nominal and Real Bond Yields
Jens H. E. Christensen, Jose A. Lopez and Glenn D. Rudebusch
Abstract: Differences between yields on comparable-maturity U.S. Treasury nominal and real debt,
the so-called breakeven inflation (BEI) rates, are widely used indicators of inflation expectations.
However, better measures of inflation expectations could be obtained by
subtracting inflation risk premiums from the BEI rates. We provide such decompositions
using an estimated affine arbitrage-free model of the term structure that captures the
pricing of both nominal and real Treasury securities. Our empirical results suggest that
long-term inflation expectations have been well anchored over the past few years, and
inflation risk premiums, although volatile, have been close to zero on average.
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