Table Of ContentAt a time when unconventional monetary policy of inflation-linked bonds and inflation-linked In Inflation
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has caused uncertainty about the global inflation derivatives. Subsequent chapters deal a
outlook to rise considerably, Inflation Markets with modelling and pricing inflation-linked tio
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provides the comprehensive guide to the fast- derivatives as well as assessing relative value
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growing market for inflation-linked and hedging in inflation-linked markets. The penultimate
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products. Detailed, practitioner oriented chapter focuses on supply and demand for rk Markets
chapters encompass supply and demand inflation-linked products, and in the final ets
dynamics, economics, financial modelling and chapter the authors discuss the drivers of
the trading aspects of inflation markets. breakeven inflation.
Inflation derivatives markets have evolved and Written by experienced inflation market B
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become more standardised and more liquid in practitioners and leading experts in the Comprehensive
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recent years. The wider investment community area, Inflation Markets is a timely and much P
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can no longer afford to ignore this deep asset needed resource for those new to the topic u
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class, and there is a large pool of investors who and the market. The authors’ backgrounds C
are looking to gain a better understanding. and experience – Paul Canty is a managing an Cohesive Guide
director and European head of inflation trading ty and
Increasingly, pension schemes, insurance at UBS in London and Markus Heider is a
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companies and other long-term investors global head of inflation research at Deutsche d
understand the need to identify and hedge Bank Global Markets – ensure that the book M
inflation exposures. This new book will deliver, provides readers with a complete and consistent a
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for the first time, an applied, complete reference framework in which to understand and analyse k
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book for all types of inflation products. inflation markets. s
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The authors begin by outlining the fundamentals The book combines technical rigour with id
of consumer price inflation and the following practical market insight to give a 360°view of er
two chapters provide in-depth examinations managing and hedging inflation risks.
PEFC Certified
this book has been
produced entirely from
sustainable papers that
are accredited as PeFC
compliant.
www.pefc.org
Inflation Risk acacg.indd 1 31/07/2012 12:09
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Inflation Markets
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Inflation Markets
A Comprehensive and Cohesive Guide
Paul Canty and Markus Heider
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Published by Risk Books, a Division of Incisive Media Investments Ltd
Incisive Media
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© 2012 Incisive Media
ISBN 978 1 906348 75 5
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00 Prelims MIR_Inflation Markets 01/10/2012 11:29 Page v
Contents
About the Authors vii
Preface ix
List of Abbreviations xv
CPI Compiling Institutions xix
Notation Used xxi
1 Consumer price inflation 1
2 Inflation-linked bonds 47
3 Inflation-linked derivatives 107
4 Modelling and pricing inflation-linked derivatives 135
5 Assessing relative value in inflation-linked markets 165
6 Supply and demand for inflation-linked products 197
7 The drivers of breakeven inflation 229
Annex 1 The US, Euro Area and UK inflation markets 269
Annex 2 The other main inflation markets 307
References 347
Index 353
v
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About the Authors
Paul Canty is a managing director and global head of inflation
trading at UBS in London. He has had several technical articles
published in the field of inflation-linked securities and he was a
contributing author to the book Inflation Risks and Products published
by Risk Books. Paul holds a BSc in mathematics from Nottingham
University and an MSc in financial mathematics from Kings College
London. He started his career as a chartered accountant with Ernst &
Young.
Markus Heideris global head of inflation research at Deutsche Bank
in London. Before joining Deutsche Bank he was a university
lecturer. Markus holds a PhD in economics with a dissertation topic
on inflation. He has been a speaker at numerous inflation confer-
ences.
vii
00 Prelims MIR_Inflation Markets 01/10/2012 11:29 Page viii
00 Prelims MIR_Inflation Markets 01/10/2012 11:29 Page ix
Preface
Inflation markets have seen some spectacular growth since the end
of the 1990s in terms of the number of market participants involved,
as well as for the volumes and variety of instruments traded. In 2011,
the total market value of sovereign inflation- linked bonds (ILBs) in
advanced economies exceeded US$1.8 trillion, as compared to
around US$200 billion in 1998; in key markets such as the US, the UK
and France, ILBs accounted for about 8–20% of the total government
bond market. In many Latin American economies, ILB issuance has
long played an important role in government financing, while in
2012 Japan appeared to be considering a revival of ILB issuance and
other Asian sovereigns have progressively entered the inflation
space since the late 2000s.
Despite the strong growth, the number of available, specialised
textbooks on inflation markets remains surprisingly limited. Perhaps
one reason for this is that a consensus on the most appropriate way to
analyse market trends – in terms of both the drivers considered and
the tools used – has been emerging only gradually. Another reason
may be that, conceptually, inflation- linked securities – bonds, swaps,
asset swaps or options – resemble traditional fixed income instru-
ments. However, the payout of inflation securities is mechanically
linked to a price index, and trends in the latter are determined by
statistical and economic factors. This has important implications for
the value assessment as well as for the financial modelling of infla-
tion assets; financial and macroeconomic information and
knowledge are necessary when analysing those markets, and a
comprehensive textbook would need to cover both. On the other
hand, selecting the relevant aspects from the vast body of literature
available on interest rate markets and the economics of inflation is
also difficult. This perhaps helps to explain why the few specialised
inflation market textbooks in existence have often focused on one
aspect of inflation markets (eg, modelling) or been comprised of a
relatively loose collection of individual articles.
ix
