Discussion Paper
Short-Dated Term Premia and the Level of Inflation
Abstract: Since the advent of derivatives trading on short-term interest rates in the 1980s, financial commentators have often interpreted market prices as directly reflecting the expected path of future interest rates. However, market prices generally embed risk premia (or “term premia” in reference to measures of risk premia over different horizons) reflecting the compensation required to bear the risk of the asset. When term premia are large in magnitude, derivatives prices may differ substantially from investor expectations of future rates. In this post, we assess whether term premia have increased with the recent rise in inflation, given the historically positive relationship between the two series, and what this means for the interpretation of derivatives prices.
Keywords: term premia; inflation; monetary policy expectations; Federal Open Market Committee (FOMC);
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Bibliographic Information
Provider: Federal Reserve Bank of New York
Part of Series: Liberty Street Economics
Publication Date: 2022-09-28
Number: 20220928