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Market risk and market-implied inflation expectations

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  • Orlowski, Lucjan T.
  • Soper, Carolyne

Abstract

We examine interactions between market risk and market-implied inflation expectations. We argue that these interactions are asymmetric and varied in time. Specifically, market risk becomes elevated by expectations of either very low or high expected inflation. Market risk does not react to expectations of moderate, stable inflation. In our analysis, market risk is proxied by VIX and market-implied inflation expectations are reflected by five- and ten-year breakeven inflation. We use daily data for 5 and 10 year breakeven inflation and VIX for the sample period January 3, 2003–January 24, 2019 for empirical testing. We employ asymptotic VAR, multiple breakpoint regression and Markov switching tests to examine changeable patterns in these interactions. Our tests indicate prevalence of responses of expected low inflation or deflation to higher market risk, mainly for the 5-year breakeven inflation series. These responses are particularly significant during the run-up and aftermath of the 2008 financial crisis.

Suggested Citation

  • Orlowski, Lucjan T. & Soper, Carolyne, 2019. "Market risk and market-implied inflation expectations," International Review of Financial Analysis, Elsevier, vol. 66(C).
    • Handle: RePEc:eee:finana:v:66:y:2019:i:c:s1057521919301978
    DOI: 10.1016/j.irfa.2019.101389
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    Cited by:

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    2. de Oliveira, Erick Meira & Cunha, Felipe Arias Fogliano de Souza & Palazzi, Rafael Baptista & Klotzle, Marcelo Cabus & Maçaira, Paula Medina, 2020. "On the effects of uncertainty measures on sustainability indices: An empirical investigation in a nonlinear framework," International Review of Financial Analysis, Elsevier, vol. 70(C).
    3. Hammouda, Amira & Saeed, Asif & Vidal, Marta & Vidal-García, Javier, 2023. "On the short-term persistence of mutual fund performance in Europe," Research in International Business and Finance, Elsevier, vol. 65(C).
    4. Nasir, Muhammad Ali & Huynh, Toan Luu Duc & Yarovaya, Larisa, 2020. "Inflation targeting & implications of oil shocks for inflation expectations in oil-importing and exporting economies: Evidence from three Nordic Kingdoms," International Review of Financial Analysis, Elsevier, vol. 72(C).
    5. Agnieszka M. Chomicz-Grabowska & Lucjan T. Orlowski, 2020. "Financial market risk and macroeconomic stability variables: dynamic interactions and feedback effects," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 44(4), pages 655-669, October.
    6. Nicolas Pesci & Jean-Philippe Aguilar & Victor James & Fabien Rouillé, 2022. "Inflation Forecasts and European Asset Returns: A Regime-Switching Approach," JRFM, MDPI, vol. 15(10), pages 1-20, October.

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    More about this item

    Keywords

    Market risk; VIX; Inflation risk; Breakeven inflation; Bai-Perron multiple breakpoint regression; Asymptotic VAR; Markov switching;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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