Abstract
This paper examines the inflation risk premium in affine term structure models. By estimating empirical distributions for the inflation risk premium using a new Bayesian methodology, we find a wide range of likely estimates. Credibility intervals for 5 year maturity range from about -95 to 88 basis points in the UK and -4 to 119 basis points in the US during the period of 2004-2012. Our results show that affine term structure models are unable to capture the inflation risk premium accurately. To that end, we use a Bayesian methodology to show how the financial crisis 2008 impacts the uncertainty regarding inflation risk premium. We find a substantial upward shift in the inflation risk premium in the UK while an downward shift in the US. In particular, credibility intervals shift to -105 to 150 in the UK and -50 to 92 basis points in the US.
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