World Library  
Flag as Inappropriate
Email this Article

Inflation derivative

Article Id: WHEBN0008363016
Reproduction Date:

Title: Inflation derivative  
Author: World Heritage Encyclopedia
Language: English
Subject: Inflation swap, Exotic derivative, Derivative (finance), Inflation, Year-on-Year Inflation-Indexed Swap
Publisher: World Heritage Encyclopedia

Inflation derivative

In finance, inflation derivative (or inflation-indexed derivatives) refers to an over-the-counter and exchange-traded derivative that is used to transfer inflation risk from one counterparty to another. See Exotic derivatives.

Typically, real rate swaps also come under this bracket, such as asset swaps of inflation-indexed bonds (government-issued inflation-indexed bonds, such as the Treasury Inflation Protected Securities, UK inflation-linked gilt-edged securities (ILGs), French OATeis, Italian BTPeis, German Bundeis and Japanese JGBis are prominent examples). Inflation swaps are the linear form of these derivatives. They can take a similar form to fixed versus floating interest rate swaps (which are the derivative form for fixed rate bonds), but use a real rate coupon versus floating, but also pay a redemption pickup at maturity (i.e., the derivative form of inflation-indexed bonds).

Inflation swaps are typically priced on a zero-coupon basis (ZC) (like ZCIIS for example), with payment exchanged at the end of the term. One party pays the compounded fixed rate and the other the actual inflation rate for the term. Inflation swaps can also be paid on a year-on-year basis (YOY) (like YYIIS for example) where the year-on-year rate of change of the price index is paid, typically yearly as in the case of most European YOY swaps, but also monthly for many swapped notes in the US market. Even though the coupons are paid monthly, the inflation rate used is still the year-on-year rate.

Options on inflation including interest rate caps, interest rate floors and straddles can also be traded. These are typically priced against YOY swaps, whilst the swaption is priced on the ZC curve.

Asset swaps also exist where the coupon payment of the linker (inflation bond) as well as the redemption pickup at maturity is exchanged for interest rate payments expressed as a premium or discount to LIBOR for the relevant bond coupon period, all dates are co-terminus. The redemption pickup is the above par redemption value in the case of par/par asset swaps, or the redemption above the proceeds notional in the case of the proceeds asset swap. The proceeds notional equals the dirty nominal price of the bond at the time of purchase and is used as the fixed notional on the LIBOR leg.

Real rate swaps are the nominal interest swap rate less the corresponding inflation swap. As for modelling, the trend has been either to provide :

  • a model describing at the same time, nominal rates, real rates and inflation and representing the inflation as the exchange rate between nominal and real rates. The first type of model along these lines has been the one of Jarrow and Yildirim.
  • a market model that represent the inflation like a real asset and uses similar ideas as the one of BGM to represent the inflation returns. The first type of model along these lines has been the one of Blegrade, Benhamou, Koehler[1] that is commercially available in Pricing Partners modelling suite.[2] Another more advanced version has been the one of Fabio Mercurio and Nicola Moreni[3]

External links

  • ISDA Inflation Derivatives Definitions
  • Hughston; "Inflation Derivatives"
  • Jarrow & Yildirim; "Pricing Treasury Inflation Protected Securities and Related Derivatives using an HJM Model" Journal of Financial and Quantitative Analysis, Vol. 38, No. 2, June 2003
  • Huang & Cairns; "Valuation and Hedging of LPI Liabilities"
  • Hoare Capital Markets LLP
  • "Savvysoft prices inflation derivatives


  • Brice Benaben; "Inflation-Linked Products: A Guide for Asset and Liability Managers" Risk Books, 2005. ISBN 1-904339-60-3.
  • Deacon, Mark, Andrew Derry, and Dariush Mirfendereski; Inflation-Indexed Securities: Bonds, Swaps, and Other Derivatives (2nd edition, 2004) Wiley Finance. ISBN 0-470-86812-0.
  • Brigo, Damiano and Fabio Mercurio; "Interest Rate Models -- Theory and Practice, with Smile, Inflation, and Credit" (2nd edition, 2006) Springer Finance. ISBN 3-540-22149-2.
  • Canty, Paul and Markus Heider; "Inflation Markets: A Comprehensive and Cohesive Guide" (2012) Risk Books. ISBN 9781906348755.


  1. ^ A Market Model for Inflation by Nabyl Belgrade, Eric Benhamou, Etienne Koehler, January 2004
  2. ^ Pricing Partners Extends Significantly its Inflation Module with the Market Standard BBK Model, June 2009
  3. ^ Pricing Inflation Indexed options with stochastic volatility, Fabio Mercurio, Nicola Moreni, August 2005
This article was sourced from Creative Commons Attribution-ShareAlike License; additional terms may apply. World Heritage Encyclopedia content is assembled from numerous content providers, Open Access Publishing, and in compliance with The Fair Access to Science and Technology Research Act (FASTR), Wikimedia Foundation, Inc., Public Library of Science, The Encyclopedia of Life, Open Book Publishers (OBP), PubMed, U.S. National Library of Medicine, National Center for Biotechnology Information, U.S. National Library of Medicine, National Institutes of Health (NIH), U.S. Department of Health & Human Services, and, which sources content from all federal, state, local, tribal, and territorial government publication portals (.gov, .mil, .edu). Funding for and content contributors is made possible from the U.S. Congress, E-Government Act of 2002.
Crowd sourced content that is contributed to World Heritage Encyclopedia is peer reviewed and edited by our editorial staff to ensure quality scholarly research articles.
By using this site, you agree to the Terms of Use and Privacy Policy. World Heritage Encyclopedia™ is a registered trademark of the World Public Library Association, a non-profit organization.

Copyright © World Library Foundation. All rights reserved. eBooks from World eBook Library are sponsored by the World Library Foundation,
a 501c(4) Member's Support Non-Profit Organization, and is NOT affiliated with any governmental agency or department.