Headline inflation in most industrialized countries, the US in particular, has been shown to be mean reverting to core inflation in the medium term, whilst at the same time the pass-through of exogenous commodity price shocks from the headline to the core has dramatically gone down as a result of a major macroeconomic paradigm change. It yields lower relative volatility for the latter and creates a drive for investing in commodities as a hedge for the spread between both inflation measures. In this paper, we argue for a risk reduction in ALM strategy in the form of a shift from targeting core rather than headline inflation for long-term hedgers while proposing an overlaying core versus headline swap to hedge the potential asset-liability gap. A market curve for core inflation could be derived from the trading of these derivatives and enable easy mark-to-market valuation of any core-linked securities, thus easing the way for future primary issues. Any supply and demand market disequilibria between long-term sellers of headline inflation and shortterm sellers of core inflation could be matched by the intermediation of market makers which could price the derivative based on the crosshedging potential of commodities.
This article tries to solve the portfolio inflation hedging problem by introducing a new class of dynamic trading strategies derived from classic portfolio insurance techniques adapted to the real world. These strategies aim at yielding higher returns on a riskadjusted basis than regular inflation hedging portfolio allocation while achieving a lower cost than comparable option-based guaranteed real value strategies.
According to the macro-econometric literature, the impact of exogenous oil price shocks on Inflation have greatly increased in the last two decades throughout OECD countries while the persistence of those shocks on long-term inflation, namely core inflation, has dramatically decreased. In the meantime, the market for inflation derivatives soared, spurred by a revival of the primary inflation-linked bond market. As the contribution of core inflation to the total headline inflation volatility bottomed, most of the volatility of headline inflation should thus be explained by changes in the spread between headline and core inflation indicators: a factor closely linked to commodity markets. This economic analysis should have important financial arbitrage implications in the futures market: are exogenous shocks on oil futures markets incorporated into zero coupon inflation indexed swap prices? To investigate this issue, we propose on the one hand a four-factor model for both inflation and nominal rates, and on the other hand a two-factor model for commodities. We proceed to an empirical estimation of the model using prices of oil futures contracts and inflation breakeven rates from which we can in particular extract a synthetic core inflation forward curve.
scite is a Brooklyn-based organization that helps researchers better discover and understand research articles through Smart Citations–citations that display the context of the citation and describe whether the article provides supporting or contrasting evidence. scite is used by students and researchers from around the world and is funded in part by the National Science Foundation and the National Institute on Drug Abuse of the National Institutes of Health.