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Pricing inflation-linked bonds

By Paolo Falbo, Francesco Paris and Cristian Pelizzari

Abstract

This paper proposes a pricing model for inflation-linked bonds. Our proposal is developed starting from a Vasicek model of the instantaneous inflation rate process and the Cox, Ingersoll and Ross model for the nominal instantaneous risk-free interest rate process. Instead of adopting the standard approach of a cross-section estimation of the term structure of real interest rates, this work proposes a pricing model based on estimation of the inflation risk premium. The model is applied to Treasury Inflation Protected Securities, which are inflation-linked bonds issued by the U.S. Department of the Treasury. Empirical validation is carried out on data for the period 1999-2005.Interest rates, Inflation-linked bonds, Continuous time stochastic models, Inflation rates, Treasury Inflation Protected Securities,

DOI identifier: 10.1080/14697680802613057
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