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Journal Article
Developing a liquid market for inflation-indexed government securities: lessons from earlier experiences
After a slow start in the 1980s, inflation-indexed government securities have gradually become more common in developed countries. A number of potential benefits arise with a government conducting part of its borrowing through inflation-indexed securities. Chief among them are better risk sharing for the economy, reduced government borrowing costs, less incentive for a deeply indebted government to inflate away its debt, and a new source of information about investors? inflation expectations. Many developed countries in coming decades will face the need to borrow more to finance the ...
Working Paper
Bank derivative activity in the 1990s
This paper tries to grasp banks' motivation for entering derivative markets. The motivation question is interesting for the following reason: if banks' main motivation for using derivatives is speculation, derivatives are likely to increase the risk to banks' capital and thus increase the cost of deposit insurance. ; The first major finding of the paper is that currently available data are not informative of banks' usage of derivatives. We find no evidence that derivatives are mainly used for speculation purposes. There is some indication that users of derivatives are interested in expanding ...
Journal Article
Liquidity risk premia and breakeven inflation rates
In recent years, monetary policymakers have monitored several measures of market expectations of future inflation. One of these measures is based on the yield differential between nominal and inflation indexed Treasury securities. This yield spread is also called the ?breakeven inflation rate.? An increase in the breakeven rate is sometimes viewed as a sign that market inflation expectations may be on the rise. For example, the FOMC frequently refers to the yield spread as a measure of ?inflation compensation? and considers the yield spread an indicator of inflation expectations in policy ...
Journal Article
Can TIPS help identify long-term inflation expectations?
Investors and policymakers have long hoped that Treasury Inflation Protected Securities (TIPS) would provide an accurate measure of long-term market inflation expectations. To make informed decisions and to ensure that inflation does not erode the purchasing power of their assets, investors need to assess the rate of inflation expected by other market participants. Having an accurate measure of market inflation expectations can also help policymakers assess their effectiveness in controlling long-term inflation, as well as their credibility among market participants.> Until recently, however, ...
Journal Article
Benefits and limitations of inflation indexed Treasury bonds
In recent years, members of Congress and academia have repeatedly urged the U.S. Treasury to issue some portion of its debt in the form of inflation indexed bonds. With an indexed bond, the interest and maturity value are adjusted by the rate of inflation over the life of the bond. Because the cash flow of an indexed bond is adjusted for inflation, the bond's real value does not vary with inflation, protecting investors and issuers alike from inflation risk.> Inflation indexed bonds would be a fundamental innovation in U.S. financial markets, providing benefits to investors, the Treasury, and ...
Working Paper
Market timing strategies that worked
In this paper, we present a few simple market-timing strategies that appear to outperform the "buy-and-hold" strategy, with real-time data from 1970 to 2000. Our focus is on spreads between the E/P ratio of the S&P 500 index and interest rates. Extremely low spreads, as compared to their historical ranges, appear to predict higher frequencies of subsequent market downturns in monthly data. We construct "horse races" between switching strategies based on extremely low spreads and the market index. Switching strategies call for investing in the stock market index unless spreads are lower ...
Journal Article
How important is the inflation risk premium?
Investors and market analysts generally believe that the yield on a nominal bond includes an inflation risk premium to compensate investors for bearing the inflation risk associated with the bond. Knowing how much of a risk premium investors require on nominal bonds can be valuable information for policymakers. For government Treasuries, the size of the risk premium represents the potential interest savings for governments when nominal securities are replaced with real, or inflation-indexed, securities. And, because the inflation risk premium reflects perceived inflation uncertainty, changes ...
Journal Article
Why has the nonfinancial commercial paper market shrunk recently?
The total volume of nonfinancial commercial paper outstanding peaked in the fall of 2000 and has declined rapidly ever since. By September 2002, the market had shrunk more than 50 percent. Relative to historical patterns, both the magnitude and the timing of the decline are unusual. The decline is the largest on record, and the market started to shrink before the recent recession began. In the past, the volume of commercial paper outstanding tended to increase during the early stages of recessions. ; Commercial paper is an important source of external funding for corporate borrowers and has ...
Journal Article
Settlement risk in large-value payments systems
The phenomenal growth of financial market and trading activities worldwide has led to tremendous growth in large-value payments systems. Large-value payments systems are the electronic banks used to transfer large payments among themselves. Payment orders processed in such systems in the United States, for example, are typically well above $1 million. ; The tremendous growth of payments system use throughout the world has increased both the possibility of settlement failures and the potential impact of such failures. In 1996, the average turnover in a single day exceeded the combined capital ...