The French Real Term Structure of Interest Rates

with Implicit Inflation Premium

presented by

J. Huston McCulloch

Department of Economics, Ohio State University

Data for 12/29/00

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Charts

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The second chart shows a comparison nominal term structure for Euro-denominated French Treasury bonds (OAT). Although there are 31 such bonds that are actively traded, only the two with maturities closest to the two outstanding indexed bonds (4/2009 and 4/2029) are employed for this comparison, in order to prevent the nominal side from having a much more detailed shape than the real side.

The third chart shows the forward French CPI excluding Tobacco implicit in the real and comparison nominal term structures, plotted versus calendar time, with a 2.5 month shift to the left to compensate for the 2.5 month indexation lag in the French indexed bonds (1/1/2000 = 2000.000, etc). Under perfect foresight, with no transactions costs, no taxation, etc, arbitrage would require this to be the known future course of the index.

The fourth chart shows the marginal inflation premium, which is the difference between the nominal and real forward curves, or equivalently the local rate of growth of the forward CPI curve, along with the average inflation premium, which is the difference between the nominal and real zero coupon yield curves, or equivalently the average rate of growth of the forward CPI curve, again plotted versus calendar time, with the same 2.5 month shift for the indexation lag.

The two term structures were fit by means of the "QN Spline" described in J. Huston McCulloch and Levis A. Kochin, "The Inflation Premium Implicit in the U.S. Real and Nominal Term Structures of Interest Rates," Ohio State University Working Paper No. 98-12, revised 9/2000. Comparable curves for the US, including this precise date, are on my US Real Term Structure website, q.v.

All yields shown are continuously compounded, and are therefore directly comparable to the yields on the above-linked US Real Term Structure website, even though the bonds themselves have annual coupons and are quoted with annually compounded real and nominal yields.

If Purchasing Power Parity held exactly, and abstracting from default risk and tax considerations, all investors should simply buy the highest yielding indexed bonds. Since US real yields were a little higher than French real yields on the date illustrated, this would imply that all investors should have bought the American TIPS in such a market.

However, since there are substantial deviations from PPP, particularly in the short run, bonds denominated in one's own CPI are generally safer, from one's own point of view, than those denominated in a foreign CPI. In light of this real exchange rate risk, Americans would have little if anything to gain by buying French indexed bonds on a date like that illustrated, while French investors should strongly consider mixing a few TIPS with their OATi's.

Data may be downloaded by clicking here. Graphs may be downloaded by right clicking on the image, selecting View Image, and then saving to your computer.