A Market Model for Inflation

15 Pages Posted: 17 Aug 2004

See all articles by Nabyl Belgrade

Nabyl Belgrade

CDC Ixis Capital Markets

Eric Benhamou

Université Paris Dauphine; EB AI Advisory; AI For Alpha

Etienne Koehler


Date Written: January 2004


The various macro econometrics model for inflation are helpless when it comes to the pricing of inflation derivatives. The only article targeting inflation option pricing, the Jarrow Yildirim model, relies on non observable data. This makes the estimation of the model parameters a non trivial problem. In addition, their framework do not examine any relationship between the most liquid inflation derivatives instruments: the year to year and zero coupon swap. To fill this gap, we see how to derive a model on inflation, based on traded and liquid market instrument. Applying the same strategy as the one for a market model on interest rates, we derive no-arbitrage relationship between zero coupon and year to year swaps. We explain how to compute the convexity adjustment and what relationship the volatility surface should satisfy. Within this framework, it becomes much easier to estimate model parameters and to price inflation derivatives in a consistent way.

Keywords: Inflation index, forward, zero-coupon, year-on-year, volatility cube, convexity adjustment

JEL Classification: G13, G12

Suggested Citation

Belgrade, Nabyl and Benhamou, Eric and Koehler, Etienne, A Market Model for Inflation (January 2004). Available at SSRN: https://ssrn.com/abstract=576081 or http://dx.doi.org/10.2139/ssrn.576081

Nabyl Belgrade

CDC Ixis Capital Markets ( email )

47 quai d'Austerlitz
Paris, 75013
0033 (0)158551556 (Phone)

Eric Benhamou (Contact Author)

Université Paris Dauphine ( email )

Place du Maréchal de Tassigny
Paris, Cedex 16 75775

EB AI Advisory ( email )

35 Boulevard d'Inkermann
Neuilly sur Seine, 92200

AI For Alpha ( email )

35 boulevard d'Inkermann
Neuilly sur Seine, 92200

Etienne Koehler

CNCE ( email )

33 1 58 40 56 76 (Phone)

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