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Inflation Expectations, Inflationary Risk Premium and Liquidity Premium: A Decomposition of the Break-Even Inflation for the Colombian Government’s Bonds

No. 78 (2017-03-01)
  • Juan Andrés Espinosa-Torres
  • Luis Fernando Melo-Velandia
  • José Fernando Moreno-Gutiérrez
https://doi.org/10.13043/dys.78.8

Abstract

We estimate the break-even inflation’s decomposition following a 6 factor affine term structure model for the nominal and real Colombian government’s bonds, among which a liquidity factor is included. This measure allows to be decomposed in inflation expectations, inflationary risk premium and a liquidity premium for the June 2004 to April 2015 period. Our findings show that the break-even inflation is an appropriate estimate of the short run inflation expectations (2 years). In addition, we find a time decreasing inflationary risk premium, which can be associated to an increase in the agents’ trust in the monetary policy. Finally, the liquidity premium has very small values for most of the time periods and only has considerable effects for certain periods across the yield curve, such as the first semester of 2006.

Keywords: Term structure of interest rates, affine model, break-even inflation, inflation expectations, inflationary risk premium, liquidity premium (author’s key words)

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