Retrieving Inflation Expectations and Risk Premia Effects from the Term Structure of Interest Rates

This paper suggests an empirically attractive Gaussian dynamic term structure model to retrieve estimates of real interest rates and in flation expectations from the nominal term structure of interest rates which are net of in flation risk premium effects. The paper shows that this model is consistent with the data and that time-variation of infl ation risk premium and real interest rates can explain the puzzling behavior of the spread between long and short-term nominal interest rates to forecast changes in in flation rates, especially over short-term horizons. The estimates of in flation risk premium effects retrieved by the model tend to be negative and signi ficant, which implies that investors in the bond market require less compensation for holding nominal bonds compared to in flation-indexed bonds. This is more evident during the recent fi nancial crisis