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Reading the Message from the U.K. Indexed Bond Market: Real Interest Rates, Expected Inflation and the Risk Premium

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  • Levin, Eric J
  • Copeland, Laurence S

Abstract

The eight-month lag in the indexation of the value of U.K. index-linked gilts, far from being a nuisance, actually makes possible the derivation of estimates of expected inflation from a comparison of the prices of two indexed bonds differing only in their durations, without recourse to any information from the market for conventional gilts. Nominal bond prices can then be used to derive the inflation risk premium. Following this approach, and assuming a stochastic valuation equation to allow for mispricing, the authors fit bond pricing equations to cross-section data for 44 conventional and 11 indexed gilts between 1984 and 1991. They conclude that the real interest rate has more than doubled since 1983. Copyright 1993 by Blackwell Publishers Ltd and The Victoria University of Manchester

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  • Levin, Eric J & Copeland, Laurence S, 1993. "Reading the Message from the U.K. Indexed Bond Market: Real Interest Rates, Expected Inflation and the Risk Premium," The Manchester School of Economic & Social Studies, University of Manchester, vol. 61(0), pages 13-34, Suppl..
    • Handle: RePEc:bla:manch2:v:61:y:1993:i:0:p:13-34
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    Cited by:

    1. Robertson, Donald & Symons, James, 1997. "Real Interest Rates and Index-Linked Gilts," The Manchester School of Economic & Social Studies, University of Manchester, vol. 65(1), pages 25-43, January.
    2. Kanas, Angelos, 2014. "Bond futures, inflation-indexed bonds, and inflation risk premium," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 28(C), pages 82-99.
    3. Francis Breedon & Jag Chadha, 1997. "The Information Content of the Inflation Term Structure," Bank of England working papers 75, Bank of England.
    4. Robertson, D. & Symons, J., 1993. "Five weeks in the life of the pound: interest rates," LSE Research Online Documents on Economics 20983, London School of Economics and Political Science, LSE Library.
    5. Madureira, Leonardo, 2007. "The ex ante real rate and inflation premium under a habit consumption model," Journal of Empirical Finance, Elsevier, vol. 14(3), pages 355-382, June.
    6. Juan Ayuso Huertas, 1996. "Un análisis empírico de los tipos de interés reales ex-ante en España," Investigaciones Economicas, Fundación SEPI, vol. 20(3), pages 321-338, September.

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