Real-World Key Correlation: Correlation Between Inflation, Nominal and Real Returns on 10 year Gover
Document ID: 2008-908
Published on: 31st July 2008
Author: John Hibbert, Colin Holmes, Ruosha Li
Interest rates are determined by a rich set of information. We believe that nominal interest rates contain information about future expected inflation, future expected real rates, a real term premium, an inflation risk premium and a convexity effect. By contrast, Indexed linked yields embed information about expected future real rates and a real term premium and a convexity effect. To the extent that inflation expectations and the inflation risk premium do not change over time, and assuming that bond markets are not segmented, we might expect to observe a near-perfect correlation between real and nominal bond returns. This note explains how we make long term assumptions on the correlation between nominal returns, real returns and inflation break-even rates.
