Working Paper Series no. 589: UK term structure decompositions at the zero lower bound.

Abstract

This paper employs a Zero Lower Bound (ZLB) consistent shadow-rate model to decompose UK nominal yields into expectation and term premia components. Compared to a standard affine term structure model, it performs relatively better in a ZLB setting and effectively captures the countercyclical nature of term premia. The ZLB model is then exploited to estimate inflation expectations and risk premia. This entails jointly pricing and decomposing nominal and real UK yields. We find evidence that medium- and long-term inflation expectations are contained within narrower bounds since the early 1990s, suggesting monetary policy credibility improved after the introduction of inflation targeting.

Andrea Carriero, Sarah Mouabbi and Elisabetta Vangelista
April 2016

Classification JEL : E31, E43, E52, E58, G12

Keywords : No-arbitrage, term structure, zero-lower bound, risk premia, inflation expectations.