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Can We Estimate The Inflation Risk Premium?

Brian Romanchuk profile picture
Brian Romanchuk

(NOTE: This article is an unedited first draft of a section of my upcoming book on inflation break-even analysis.)

This article continues the discussion in the previous section [in the book], focusing on our ability to calculate the inflation risk premium. The tendency among central bank and academic researchers is to focus on the answers provided by affine term structure models. I am highly skeptical about that approach, and prefer the simpler approach of analysing historical returns data. The problem with historical data analysis is the limited volume of inflation-linked returns data.

(Comments: I have largely rewritten an earlier article that was meant to be used as a section of the break-even inflation book. As a result, some text near the end may be familiar to regular readers. I am not hugely satisfied with my discussion of affine term structure models herein. Once again, I am avoiding discussing the mathematics. The book is meant to be more advanced, and it would be appropriate to delve into the mathematics. However, I would largely end up where I am here: the inclusion of consensus forecasts into the curve fitting algorithm is dubious. I do not see any point in paying thousands of dollars for consensus forecast data just so that I can replicate an algorithm that I have zero confidence in. I am currently going through my first draft, and getting it ready for publication. This section was the only section of content that I was unsure about. I have just started this pass of work; I hope to wrap it up within a couple of weeks. I will see then whether it is ready for publication.)

For the affine term structure approach, one of the issues is that academic and central bank researchers are continuously churning out papers. The class of models is

This article was written by

Brian Romanchuk profile picture
I have 15 years of experience as a senior quantitative analyst in fixed income. I specialized in the development of research systems and analytics. Currently a consultant and blogger. I have a B.Eng. in electrical engineering from McGill University, and a Ph.D. from the University of Cambridge in control systems engineering. I am a CFA Charterholder.

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