Faculty Digital Archive

Archive@NYU >
Stern School of Business >
Finance Working Papers >

Please use this identifier to cite or link to this item: http://hdl.handle.net/2451/26287

Issue Date: 25-May-2008
Series/Report no.: FIN-07-001
Abstract: Inflation expectations are a key economic variable for investors in capital markets and for economic policy decision makers. One of the widely used sources for deriving inflation expectations are market prices of bonds. The yield differential between nominal bonds and inflation-indexed (linked) bonds is taken to be an estimate of expected inflation. The problem is however that in a risk averse world the yield differential includes an inflation risk premium and thus the yield differential provides an upward bias of inflation expectations. The novelty of our paper is that we estimate this risk premium using volatility implied in options prices. In the absence of a market in options on inflation we use prices of foreign currency options to estimate this risk premium. The theoretical foundation of our methodology is purchasing power parity theory. The Israeli financial market has both, an inflation linked and non linked bond market and an active FX options market. Using data from both markets we find a statistically and economically significant inflation risk premium.
URI: http://hdl.handle.net/2451/26287
Appears in Collections:Finance Working Papers

Files in This Item:

File Description SizeFormat
07-01.pdf192.97 kBAdobe PDFView/Open

Items in Faculty Digital Archive are protected by copyright, with all rights reserved, unless otherwise indicated.


The contents of the FDA may be subject to copyright, be offered under a Creative Commons license, or be in the public domain.
Please check items for rights statements. For information about NYU’s copyright policy, see http://www.nyu.edu/footer/copyright-and-fair-use.html 
Valid XHTML 1.0 | CSS