Abstract: This paper decomposes nominal Treasury yields into expected real rates, expected inflation rates,
real risk premiums, and inflation risk premiums by separately calibrating a threefactor affine
term structure model to the nominal Treasury and TIPS yield curves. Although this particular
application seems to produce expected real short rates and inflation rates that are somewhat static,
there are theoretical advantages to calibrating the model to nominal and real yields separately.
Moreover, the estimates correlate positively with backoftheenvelope measures of the inflation
risk premium. With respect to the current environment, monetary policy uncertainty does not seem
to have contributed to the apparent increase in the inflation risk premium since the beginning of 2006.
Also, in purely nominal terms, the increase in term premiums thus far this year might be just as much a
global as a domestic phenomenon, given that nominal term premiums have also increased in Germany and the
United Kingdom.
Keywords: Affine term structure model, inflation risk premium
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Last update: November 21, 2006
