Not Risk Free: The Relative Pricing of Euro Area Inflation-Indexed and Nominal Bonds

Simon, Zorka

doi:10.2139/ssrn.2744632

Cited by 3 publications

(3 citation statements)

References 33 publications

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“…The literature already covered this topic and evidence of different credit risk on nominal and real bonds are found in Goddard and Kitab (2016) and in Simon (2015). In particular, Simon (2015) finds proof of a differing credit risk premium across nominal and real bonds issued from the main euro area countries (especially France and Italy) or, equivalently, a different exposure of nominal and real bonds to sovereign credit risk.…”

Section: Regression-based Approachmentioning

confidence: 98%

“…If the market views the default risk of nominal bonds as lower than that of ILBs, then ILBs might trade with higher credit risk premia. Second, Simon (2015) considers the possibility that the harmonized inflation rate gets substantially higher than the issuer's domestic inflation rate. In this scenario, it could become a burden to pay back the indexed bonds tied to the European harmonized index.…”

Section: Regression-based Approachmentioning

confidence: 99%

“…The vast amount of research using ILBs is mainly related to the USA. For the euro area, relevant research on the pricing of the nominal and real bonds is provided by Garcia and Werner (2010), Pericoli and Taboga (2012); Pericoli (2012), Hördahl et al (2014), Simon (2015), Camba-Mendez and Werner (2017) and Pericoli (2019).…”

Section: Introductionmentioning

confidence: 99%

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Break-even Inflation Rates: The Italian Case

Fanari

Iorio

2020

SSRN Journal

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This paper focuses on break-even inflation rates (BEIRs), a widely used market-based measure of expected inflation, computed from government bonds. In the first part of the paper, we regress the Italian BEIR on several financial variables to assess the contribution of inflation, credit and liquidity components. In the second, in order to disentangle market participants' inflation expectations from risk premia, we estimate a term structure model for the joint pricing of the Italian nominal and real yield curves, considering also credit and liquidity factors. The results show that BEIRs could be a misleading measure of the expected inflation due to the importance of inflation risk premium and credit risk effect. According to our estimates, the decrease in market-based measures of inflation observed in the last part of the sample period seems to reflect a lowering of both inflation expectations and risk premia. Inflation premia comove with a measure of tail risk of the long-term inflation distribution signalling that investors become more concerned with downside risks.

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Section: Regression-based Approachmentioning

confidence: 98%

Section: Regression-based Approachmentioning

confidence: 99%

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Break-even Inflation Rates: The Italian Case

Fanari

Iorio

2020

SSRN Journal

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Four-factor model of Quanto CDS with jumps-at-default and stochastic recovery

Itkin

Soleymani

2021

Journal of Computational Science

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Break-even inflation rates: the Italian case

Fanari

Iorio

2022

SEF

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Purpose This work aims to study the break-even inflation rates (BEIRs), a widely used market-based measure of expected inflation. The authors focus on Italian Government bonds, one of the most liquid debt markets in the euro area. Design/methodology/approach The authors set up an auto-regressive distributed lag model and regress the BEIR on a set of variables that proxy inflation, market risk aversion, protection against deflation, credit as well as liquidity risk to get some insights into the importance of these factors. Subsequently, to disentangle market participants’ inflation expectations from their associated risk premia, the authors estimate a term structure model for the joint pricing of the Italian Government’s nominal and real yield curves, considering also a credit and a liquidity pricing factor. Findings The results show that BEIRs could be a misleading measure of the expected inflation due to the importance of the inflation risk premium and the credit risk effect. According to the estimates, the decrease of market-based measures of inflation observed in the last part of the sample period seems to reflect a lowering of both inflation expectations and risk premia. Inflation premia co-move with a measure of the tail risk of the long-term inflation distribution, signalling that investors become more concerned with downside risks. Originality/value This study complements the existing literature primarily based on the USA and euro area data focusing on the Italian market. To this end, the authors modify and adapt a well-known term structure model developed for nominal and real curves.

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Not Risk Free: The Relative Pricing of Euro Area Inflation-Indexed and Nominal Bonds

Cited by 3 publications

References 33 publications

Break-even Inflation Rates: The Italian Case

Break-even Inflation Rates: The Italian Case

Four-factor model of Quanto CDS with jumps-at-default and stochastic recovery

Break-even inflation rates: the Italian case

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