Staff Reports
Decomposing Real and Nominal Yield Curves
Previous title: “Pricing TIPS and Treasuries with Linear Regressions”
2014   September 2012  Number 570
Revised October 2013
JEL classification: E43, E44, G12

Authors: Michael Abrahams, Tobias Adrian, Richard K. Crump, and Emanuel Moench

We present an affine term structure model for the joint pricing of real and nominal bond yields that accounts for illiquidity. Using the model to adjust breakevens for inflation and liquidity risk substantially improves inflation forecasts. Our estimates imply that the Federal Reserve’s large-scale asset purchases lowered Treasury yields primarily by reducing real term premia. Real term premia also account for the positive response of long-term real forward rates to surprise changes in the federal funds target. Applying our model to U.K. data, we find that the inflation risk premium dropped significantly when the Bank of England formally adopted an inflation target.

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