15.1 Introduction

Over the past decade government-issued inflation-indexed, or index-linked, bonds have become available in a number of euro-area countries and have provided a fundamentally new instrument popular among institutional investors and households, especially for retirement saving. From a policy perspective, inflation-indexed bonds can be used to extrapolate inflation expectations at different maturities. In fact, bonds linked to an inflation index differ from the corresponding standard bonds in respect of expected inflation and inflation risk premia as well as of maturities, coupon rates and cash-flow structures. In addition, as index-linked bonds have different maturities, an entire spectrum of inflation expectations and inflation risk premia can be derived from the comparison with standard nominal bonds. Hence, stemming from the no-arbitrage affine Gaussian term structure literature developed for standard bonds, some recent papers have investigated a theoretical and empirical framework to jointly price standard and index-linked bonds based on a small number of common factors. The novelty of this stream of literature, to which this chapter belongs, is to have consistent, i.e. arbitrage-free, estimates of the real and nominal interest rates as well as expected inflation rates and inflation risk premia.

This chapter estimates a no-arbitrage affine Gaussian term structure model for nominal and real zero-coupon interest rates implied in government bonds with macroeconomic surprises in the euro area and the United States.