How important is the inflation risk premium?
Author InfoPu Shen Abstract 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 in the size of the risk premium can reveal to monetary policymakers how credible their policy actions are in the marketplace. Unfortunately, empirical evidence on the actual size of the inflation risk premium and its response to market events is scarce.> To address these empirical shortcomings, Shen uses data from the United Kingdom, where about 20 percent of outstanding
