School of Economics and Finance

No. 755: UK Term Structure Decompositions at the Zero Lower Bound

Andrea Carriero , Queen Mary University of London
Sarah Mouabbi , Banque de France
Elisabetta Vangelista , UK Debt Management Office

September 28, 2015

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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.

J.E.L classification codes: E31, E43, E52, E58, G12

Keywords:No-arbitrage, Term structure, Zero-lower bound, Risk premia, Inflation Expectations