Affine Model of Inflation-Indexed Derivatives and Inflation Risk Premium

Abstract

This paper proposes an affine-based approach which jointly captures the nominal interest rate, the real interest rate, and the inflation risk premium to price inflation-indexed derivatives, including zero-coupon inflation-indexed swaps, year-on-year inflation-indexed swaps, inflation-indexed swaptions, and inflation-indexed caps and floors. We provide an example and explain how to use traded zero-coupon inflation-indexed swap rates to estimate inflation risk premiums.