Description

This paper studies the relationship between inflation compensation and inflation expectations in Chile. First, we use the present discounted value methodology to decompose the difference between the unanticipated return of nominal and inflation-linked bonds into news about expected inflation and premiums. Second, we use a general equilibrium asset-pricing model to estimate a time-varying inflation risk premium. Our results show that inflation-expectations movements account for about only 25% of the relative returns, indicating that premiums are a very important source of changes in inflation compensation. We also show that the estimated inflation risk premium is time-varying but seems to be of negligible size, with average size and volatility very close to zero.