Thursday, January 5, 2012

Inflation swaps and TIPS

Econbrowser has a post on inflation expectations as measured via TIPS spreads. This links back to an earlier comment I made on Glasner's blog, in which inflation swaps are posited as an alternative to TIPS spreads. Here is the comment from Econbrowser:

"One might worry about characteristics in the TIPS market distorting the estimates of the real yields."
 "The real yield curve starts at five years, so one can’t be sure what the real yield curve suggests for the horizon less than five years. "
 Why not use zero coupon inflation swap prices? They (supposedly) don't suffer from some of the same distortions as TIPS (liquidity premia), and you can get shorter terms.
 For instance, here is the 2 year inflation swap.
Just subtract the 2 year swap rate from the nominal 2 year rate and you have the 2 year real rate. 

See the Cleveland Fed's explanation of their methodology for measuring inflation expectations, which includes the use of  inflation swaps

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