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Investigating Excess Returns from Nominal Bonds

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  • Francis Breedon
  • Jagjit S. Chadha

Abstract

Estimated real returns on nominal bonds show excess returns of some 200 bp over their index‐linked equivalent. This paper considers two possible explanations for this large difference. First, we assess the likely inflation risk premium by calibrating a model of optimal bond prices under uncertainty. Employing either of CRRA or Abel (1990) relative consumption utility function to derive the stochastic discount factor and covariation risk, we suggest that the inflation risk component of this excess return is unlikely to be much above 50 bp. Secondly, we find little evidence that these excess returns can be ascribed to consistent expectational errors in predicting inflation.

Suggested Citation

  • Francis Breedon & Jagjit S. Chadha, 2003. "Investigating Excess Returns from Nominal Bonds," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 65(1), pages 73-90, February.
    • Handle: RePEc:bla:obuest:v:65:y:2003:i:1:p:73-90
    DOI: 10.1111/1468-0084.00043
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    References listed on IDEAS

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    Cited by:

    1. 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.
    2. Andrew Adams & Seth Armitage & Adrian FitzGerald, 2011. "Stock market volatility in a simple framework," CFI Discussion Papers 1101, Centre for Finance and Investment, Heriot Watt University.
    3. Jagjit S. Chadha, 2012. "World Real Interest Rates: A Tale of Two Regimes," Studies in Economics 1205, School of Economics, University of Kent.
    4. Peter S. Spiro, 2003. "Evidence on inflation expectations from Canadian real return bonds," Macroeconomics 0312004, University Library of Munich, Germany.
    5. Yongo Kwon, 2019. "Nominal GDP growth indexed bonds: Business Cycle and Welfare Effects within the Framework of New Keynesian DSGE model," National Institute of Economic and Social Research (NIESR) Discussion Papers 504, National Institute of Economic and Social Research.
    6. Luca Larcher & Francis Breedon, 2020. "Discounting and the market valuation of defined benefit pensions," Working Papers 932, Queen Mary University of London, School of Economics and Finance.

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