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Are Indexed Bonds Really Inflation Proof? A Model of Real and Nominal Term Structures when Money has Real Effects

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Abstract

This paper studies the general behavior of the nominal and real term structures of interest rates in a general equilibrium framework. A central bank is introduced in the model as an agent facing a tradeoff between inflation and output and choosing a monetary policy variable. Prices and output are jointly determined in our model endogenously. Two multi-factor nominal and real term structure models are given as examples to illustrate the general model. In our economies, inflation indexed bonds are not completely inflation proof, but are still subject to the influence of inflation uncertainties. The models offer us an empirical framework that can be studied with indexed bond data and nominal bond data together in a single estimation.

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Authors and Affiliations

  1. Department of Finance, The Fox School of Business and Management, Temple University, Philadelphia, PA, 19122, USA

    Connie X. Mao

  2. China Securities Regulatory Commission, 16 ** Rong Street, ** Cheng District, Bei**g, 100032, P.R. China

    Ning Zhang

  3. Department of Finance, Graduate School of Business and Management, Fordham University, New York, NY, 10023, USA

    Rui Zhong

Authors
  1. Connie X. Mao
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  2. Ning Zhang
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  3. Rui Zhong
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Correspondence to Rui Zhong.

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Mao, C.X., Zhang, N. & Zhong, R. Are Indexed Bonds Really Inflation Proof? A Model of Real and Nominal Term Structures when Money has Real Effects. Review of Quantitative Finance and Accounting 21, 65–94 (2003). https://doi.org/10.1023/A:1024859706116

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