Estimating Real and Nominal Term Structures Using Treasury Yields, Inflation, Inflation Forecasts, and Inflation Swap Rates

Abstract

This paper develops and estimates an equilibrium model of the term structures of nominal and real interest rates. The term structures are driven by state variables that include the short term real interest rate, expected inflation, a factor that models the changing level to which inflation is expected to revert, as well as four volatility factors that follow GARCH processes. We derive analytical solutions for the prices of nominal bonds, inflation-indexed bonds that have an indexation lag, the term structure of expected inflation, and inflation swap rates. The model parameters are estimated using data on nominal Treasury yields, survey forecasts of inflation, and inflation swap rates.