Break-even Rates Research Articles

The fiscal effects of tax-credit scholarship programs in the United States

ABSTRACTThis article conducts a fiscal analysis of 10 tax-credit programs in seven states. In total, the 10 programs in the present study represent 90% of all scholarships awarded in tax-credit scholarship programs today. The analysis employs a set of cautious assumptions about switcher rates and students who receive multiple scholarships to generate a range of estimates of the net fiscal impact of these tax-credit scholarship programs on state and local taxpayers. Tax-credit scholarship programs up to fiscal year (FY) 2014 generated positive fiscal impacts worth between $1,650 and $3,000 per scholarship student. In FY 2014 alone, tax-credit scholarship programs generated between about $2 million and $223 million for their states. Break-even switcher rates for fiscal neutrality are reported for all programs.

Extraction of Inflation Expectations from Financial Instruments in Latin America

In this paper we estimate inflation expectations for several Latin American countries using an affine model that takes as factors the observed inflation and the parameters generated from zero-coupon yield curves of nominal bonds. By implementing this approach, we avoid the use of inflation-linked securities, which are scarce in many of these markets, and obtain market measures of inflation expectations free of any risk premium, eliminating potential biases included in other measures such as breakeven rates. Our method provides several advantages, as we can compute inflation expectations at any horizon and forward rates such as the expected inflation over the five year period that begins five years from today. We find that inflation expectations in the long-run are fairly anchored in Chile and Mexico, while those in Brazil and Colombia are more volatile and less anchored. We also find that expected inflation increases at longer horizons in Brazil and Chile, while it is decreasing in Colombia and Mexico.

Not Risk Free: The Relative Pricing of Euro Area Inflation-Indexed and Nominal Bonds

Selective default is an event in which a sovereign issuer chooses not to meet obligations on a class of bonds, while servicing her other debt. This paper presents unique empirical evidence of selective default risk premium in inflation-linked sovereign bond (ILB) yields of Germany, France and Italy. I identify this effect from the difference of breakeven rates from country pairs. Differencing controls for common components, such as the effect of inflation expectations, monetary policy or interest rate risk. I find that the remaining part in breakeven rates is explained by two systematic risk factors, liquidity and sovereign credit risks - both within and across countries. I link these findings to the ILB-nominal puzzle, which shows that ILBs are underpriced relative to nominal bonds of the same issuer. I show that this underpricing is in part due to relative risk premia differences between nominal and inflation-linked debt: ILBs are less liquid, moreover investors perceive them to have higher credit risk during the financial and euro crises. This implies an implicit seniority and a subsequent convenience yield in nominal bonds.

Variance Risk Premia on Stocks and Bonds

We study equity (EVRP) and Treasury variance risk premia (TVRP) jointly and document a number of novel facts: First, relative to their volatility, TVRP are comparable in magnitude to EVRP. Second, while there is mild positive co-movement between EVRP and TVRP unconditionally, time series estimates of correlation display distinct spikes in both directions and have been notably more volatile since the financial crisis. Third (i) short maturity TVRP predict excess returns on short maturity bonds; (ii) long maturity TVRP and EVRP predict excess returns on long maturity bonds; and (iii) while EVRP predict equity returns for horizons up to 6-months, long maturity TVRP contains robust information for equity returns at longer horizons. Finally, exploiting the dynamics of real and nominal Treasuries we document that short maturity break-even rates are a power determinant of the joint dynamics of EVRP, TVRP and their co-movement. We argue this result is consistent with an inflation signalling role in deflationary economic environments.

Inflation Expectations and the News

This paper provides new evidence on the importance of inflation expectations for variation in nominal interest rates, based on both market-based and survey-based measures of inflation expectations. Using the information in TIPS breakeven rates and inflation swap rates, I document that movements in inflation compensation are important for explaining variation in long-term nominal interest rates, both unconditionally as well as conditionally on macroeconomic data surprises. Daily changes in inflation compensation and changes in long-term nominal rates generally display a close statistical relationship. The sensitivity of inflation compensation to macroeconomic data surprises is substantial, and it explains a sizable share of the macro response of nominal rates. The paper also documents that survey expectations of inflation exhibit significant comovement with variation in nominal interest rates, as well as significant responses to macroeconomic news.

Inflation Expectations and the News

This paper provides new evidence on the importance of inflation expectations for variation in nominal interest rates, based on both market-based and survey-based measures of inflation expectations. Using the information in TIPS breakeven rates and inflation swap rates, I document that movements in inflation compensation are important for explaining variation in long-term nominal interest rates, both unconditionally as well as conditionally on macroeconomic data surprises. Daily changes in inflation compensation and changes in long-term nominal rates generally display a close statistical relationship. The sensitivity of inflation compensation to macroeconomic data surprises is substantial, and it explains a sizable share of the macro response of nominal rates. The paper also documents that survey expectations of inflation exhibit significant comovement with variation in nominal interest rates, as well as significant responses to macroeconomic news.

Tips from TIPS: The Informational Content of Treasury Inflation-Protected Security Prices

We examine the informational content of TIPS yields from the viewpoint of a general 3-factor no-arbitrage term structure model of inflation and interest rates. Our empirical results indicate that TIPS yields contained a that was until recently quite large (~1%). Key features of this premium are difficult to account for in a rational pricing framework, suggesting that TIPS may not have been priced efficiently in its early years. Besides the liquidity premium, a time-varying inflation risk premium complicates the interpretation of the TIPS breakeven inflation rate (the difference between the nominal and TIPS yields). Nonetheless, high-frequency variation in the TIPS breakeven rates is similar to the variation in inflation expectations implied by the model, lending support to the view that TIPS breakeven inflation rates are a useful proxy for inflation expectations.

Cross-Hedging of Inflation Derivatives on Commodities: The Informational Content of Futures Markets

According to the macro-econometric literature, the impact of exogenous oil price shocks on Inflation have greatly increased in the last two decades throughout OECD countries while the persistence of those shocks on long-term inflation, namely core inflation, has dramatically decreased. In the meantime, the market for inflation derivatives soared, spurred by a revival of the primary inflation-linked bond market. As the contribution of core inflation to the total headline inflation volatility bottomed, most of the volatility of headline inflation should thus be explained by changes in the spread between headline and core inflation indicators: a factor closely linked to commodity markets. This economic analysis should have important financial arbitrage implications in the futures market: are exogenous shocks on oil futures markets incorporated into zero coupon inflation indexed swap prices? To investigate this issue, we propose on the one hand a four-factor model for both inflation and nominal rates, and on the other hand a two-factor model for commodities. We proceed to an empirical estimation of the model using prices of oil futures contracts and inflation breakeven rates from which we can in particular extract a synthetic core inflation forward curve.

Cross-Hedging of Inflation Derivatives on Commodities: The Informational Content of Futures Markets

According to the macro-econometric literature, the impact of exogenous oil price shocks on Inflation have greatly increased in the last two decades throughout OECD countries while the persistence of those shocks on long-term inflation, namely core inflation, has dramatically decreased. In the meantime, the market for inflation derivatives soared, spurred by a revival of the primary inflation-linked bond market. As the contribution of core inflation to the total headline inflation volatility bottomed, most of the volatility of headline inflation should thus be explained by changes in the spread between headline and core inflation indicators: a factor closely linked to commodity markets. This economic analysis should have important financial arbitrage implications in the futures market: are exogenous shocks on oil futures markets incorporated into zero coupon inflation indexed swap prices? To investigate this issue, we propose on the one hand a four-factor model for both inflation and nominal rates, and on the other hand a two-factor model for commodities. We proceed to an empirical estimation of the model using prices of oil futures contracts and inflation breakeven rates from which we can in particular extract a synthetic core inflation forward curve.

Incorporating Linkers in a Global Government BondRisk Model

Many governments around the world now issue inflation-protected securities, or linkers, alongside conventional nominal bonds. This extends the fixed-income investment universe. Investors may not know how to build these new securities into a bond-risk model that captures overall global-price covariance. The author studies this question through the international capital asset pricing model approach, which decomposes risk into a global systematic component and a local specific component. The challenge is to fit a linear factor model onto the triangular relationship that exists between the nominal bond yields, the inflation-linked bond yields, and yield spreads called the inflation break-even rates. The author’s model provides a consistent view of risk for internationally invested portfolios containing nominal bonds, linkers, and/or inflation swaps. <b>TOPICS:</b>Fixed-income portfolio management, technical analysis, global

Cross-Hedging of Inflation Derivatives on Commodities: The Informational Content of Futures Markets

According to the macro-econometric literature, the impact of exogenous oil price shocks on Inflation have greatly increased in the last two decades throughout OECD countries while the persistence of those shocks on long-term inflation, namely core inflation, has dramatically decreased. In the meantime, the market for inflation derivatives soared, spurred by a revival of the primary inflation-linked bond market. As the contribution of core inflation to the total headline inflation volatility bottomed, most of the volatility of headline inflation should thus be explained by changes in the spread between headline and core inflation indicators: a factor closely linked to commodity markets. This economic analysis should have important financial arbitrage implications in the futures market: are exogenous shocks on oil futures markets incorporated into zero coupon inflation indexed swap prices? To investigate this issue, we propose on the one hand a four-factor model for both inflation and nominal rates, and on the other hand a two-factor model for commodities. We proceed to an empirical estimation of the model using prices of oil futures contracts and inflation breakeven rates from which we can in particular extract a synthetic core inflation forward curve.

Inflation expectations from index-linked bonds: Correcting for liquidity and inflation risk premia

We propose a novel method to correct break-even inflation rates derived from index-linked bonds for liquidity and inflation risk premia without resorting to survey based measures. In a state-space framework the difference between break-even inflation rates and unobserved true inflation expectation is explained by measures of time-varying liquidity and inflation risk premia. Our results have better forecasting performance for the average annual inflation rate over the following 10 years than raw break-even rates and the Survey of Professional Forecasters.

Extracting Inflation Expectations and Inflation Risk Premia from the Term Structure: A Joint Model of the UK Nominal and Real Yield Curves

This paper analyses the nominal and real interest rate term structures in the United Kingdom over the fifteen-year period that the UK monetary authorities have pursued an explicit inflation target, using a four-factor essentially affine term structure model. The model imposes no-arbitrage restrictions across nominal and real yields, enabling us to decompose nominal forward rates into expected real short rates, expected inflation, real term premia and inflation risk premia. We find that inflation risk premia and longer-term inflation expectations fell significantly when the Bank of England was made operationally independent in 1997. The 'conundrum' of unusually low long-term real rates that began in 2004 is mainly attributed by the model to a fall in real term premia, though a significant part of the fall is left unexplained. The relative inability of the model to fit long real forwards during much of this recent period may reflect strong pension fund demand for index-linked bonds. Moreover, the model decompositions suggest that these special factors affecting the index-linked market may also partly account for the contemporaneous rise in longer-horizon inflation breakeven rates.

Monetary Independence under Floating Exchange Rates: Evidence Based on International Breakeven Inflation Rates

It is widely assumed that, under flexible foreign exchange (FX) rates, countries may pursue an independent monetary policy with respect to domestic goals. By contrast, recent empirical evidence suggests that, similar to pegs, floating regimes are affected by transmissions of nominal quantities such as inflation or nominal interest rates from abroad. For the case of a four dimensional subsystem of the G7, we highlight the strength of international comovements in liquidity adjusted breakeven inflation interpreted as a measure of future inflation prospects. Results indicate that economies with geographical proximity and strong trade linkages (e.g. Canada and the U.S., the UK and EMU) share highest realized correlations of nonstationary breakeven rates. Moreover, these linkages appear strengthened if corresponding exchange rates are relatively stable or if the respective large economy is in a state of relatively uncertain inflation expectations.

Tips from TIPS: The Informational Content of Treasury Inflation-Protected Security Prices

We examine the informational content of TIPS yields from the viewpoint of a general 3-factor no-arbitrage term structure model of inflation and interest rates. Our empirical results indicate that TIPS yields contained a &amp;amp;#x27;liquidity premium&amp;amp;#x27; that was until recently quite large (~1%). Key features of this premium are difficult to account for in a rational pricing framework, suggesting that TIPS may not have been priced efficiently in its early years. Besides the liquidity premium, a time-varying inflation risk premium complicates the interpretation of the TIPS breakeven inflation rate (the difference between the nominal and TIPS yields). Nonetheless, high-frequency variation in the TIPS breakeven rates is similar to the variation in inflation expectations implied by the model, lending support to the view that TIPS breakeven inflation rates are a useful proxy for inflation expectations.

Estimating short-run costs of a barge company

By extending a methodology developed by the US Army Corps of Engineers, firm-specific short-run costs of a barge company are estimated in this paper. The estimated costs include average costs, marginal costs, and cost elasticities. These estimates led to a breakeven analysis and an analysis of financial conditions of the barge industry in general. Findings include that the breakeven ton-mile rates range from 0. 52 to 0.72 cents for a full-capacity operation and that the costs of barge services are highly inelastic. A questionnaire survey of 256 barge and towing companies has also been shown to corroborate the findings of this paper.

Evaluating and Comparing Projects: Simple Detection of False Alarms

THOSE WHO WORK REGULARLY with investment projects know that, if a project requires significant net cash infusions after the initial investment, multiple rates of return can potentially occur, and there has been considerable interest in the financial literature in simple methods of ruling out this possibility. Table 1 shows, for example, the projected yearly after-tax cash flows to an investor in the 50% tax bracket from one partnership unit in an FHA-insured Section 8 housing project for the elderly in Atlanta, Ga. Investment is required in years 0, 2, 3, 4, and 20. The large outflow in year 20 reflects the tax consequences of recapture of accelerated depreciation. Many oil-well projects also have three investment periods. Do the three separated intervals of negative cash flow mean that the project has multiple rates of return? Comparing projects An equivalent difficulty can easily arise when two mutually exclusive projects are being compared for possible adoption. The difference between the present values of two projects is precisely the present value of the stream of period-byperiod cash-flow differences between them. Of course, this present value varies according to the interest rate considered. An internal rate of return of the stream of differences is a interest rate at which the two projects have equal present value. If there is no such breakeven rate, that is, if the difference stream has no internal rate of return, then one project dominates the other, being preferable at all interest rates. If there are several breakeven rates, then preference between the projects switches several times as the interest rate varies. The cash-flow differences can easily change sign frequently-for example, if one project is subject to wider swings or less frequent payments than another, as in Table 2. (We keep the numbers in our examples small, for clarity, but they could, of course, denote millions of dollars.) Is there more than one interest rate at which Projects A and B are equally desirable? (For answers, see Section 6.7.)