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Inflation Risk Across the Board
Jan 1, 2010
Inflation markets have evolved significantly in recent last years. In addition to stronger issuance programs of inflation-linked debt from governments, derivatives have developed, allowing a broader set of market participants to start trading inflation as a new asset class. These changes call for modifications of risk management and pricing models. While the real rate framework allowed us to apply the familiar nominal bond techniques on linkers, it does not provide a consistent view with inflation derivative markets, and limits our ability to report inflation risk. We thus introduce in detail the concept of Break-Even Inflation and develop associated pricing models. We describe various adjustments for taking into account indexation mechanisms and seasonality in realized inflation. The adjusted break-even framework consolidates views across financial products and geography. Inflation risk can now be explicitly defined and monitored as any other risk class.
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