Inflation and the term structure

Professor Stéphane Gregoir is calling for a radical change in the way we think about inflation. “Over the past 30 years, inflation dynamics have been changing. Institutional modifications, globalisation as well as monetary, trade and competition policies have all affected its causes, magnitude and spread,” he says. “We must take into account these changes in the way we react to and design policies to contain inflation, especially given its current upsurge. If we don’t rethink inflation dynamics, we risk suboptimal real and financial asset allocations and major welfare losses.”
Leading a team at EDHEC Business School, Professor Gregoir is developing a more structural model of inflation that accounts for changes in its volatility over time as well as developed countries’ increasing economic openness and deregulatory policies. The second part of the project explores the implications of this new modelling strategy for bond pricing. “While traditional models were only based on financial information, recent research has linked the bond market to the dynamics of macroeconomic variables,” he explains. “Rather than describing or forecasting term structure’s movements, this new approach aims to understand how it is influenced by the economy. Inflation is key to such modelling.”
The two-part research project aims to benefit institutions as well as financial and insurance firms. “Our goal is to give practitioners a better understanding of inflation sources’ propagation mechanisms so they can design short- and long-term hedging strategies against inflationary risks,” says Professor Gregoir. “This work may help monetary authorities formulate more effective policies by providing them with an econometric modelling of the consequences of inflation changes.”