New paper on estimating liquidity premia in sovereign bond yields

Many market analysts use breakeven inflation (calculated as the difference between nominal and real yield on bonds with the same maturity) to measure market-implied inflation expectations (see estimates for South Africa here). The problem with breakeven inflation as a measure of inflation expectations is that it could be contaminated by liquidity risk premia. In a paper recently published in the Journal of International Economics, Remy Beauregard, Jens Christensen, Eric Fischer and Simon Zhu use a dynamic term structure model to quantify liquidity premia in nominal and inflation-linked bonds and more reliably estimate inflation expectations in a Mexican context. The paper shows how this enables assessment of how well anchored inflation expectations are. Jens and I are working on a paper in which we build on this approach, adding adjustments for changes in the credit risk embedded in government bonds, applied to the South African bond market.