Article
Market Risk and Market-Implied Inflation Expectations
International Review of Financial Analysis
(2019)
Abstract
We examine interactions between market risk and market-implied inflation expectations. We argue
that these interactions are asymmetric and varied in time. Specifically, market risk becomes
elevated by expectations of either very low or high expected inflation. Market risk does not react
to expectations of moderate, stable inflation. In our analysis, market risk is proxied by VIX and
market-implied inflation expectations are reflected by five- and ten-year breakeven inflation. We
use daily data for 5 and 10 year breakeven inflation and VIX for the sample period January 3, 2003
– January 24, 2019 for empirical testing. We employ asymptotic VAR, multiple breakpoint
regression and Markov switching tests to examine changeable patterns in these interactions. Our
tests indicate prevalence of responses of expected low inflation or deflation to higher market risk,
mainly for the 5-year breakeven inflation series. These responses are particularly significant during
the run-up and aftermath of the 2008 financial crisis.
Keywords
- Market risk,
- VIX,
- Inflation risk,
- Breakeven inflation,
- Bai-Perron multiple breakeven regression,
- Asymptotic VAR,
- Markov switching
Disciplines
Publication Date
2019
DOI
10.1016/j.irfa.2019.101389
Publisher Statement
Version posted is the journal pre-proof. It is not yet the definitive version of record.
Citation Information
Orlowski, L. T. & Soper, C. (2019). Market risk and market-implied
inflation expectations. International Review of Financial Analysis. doi: 10.1016/j.irfa.2019.101389