Does anyone have any ideas on how to risk model Inflation linked bonds? I am looking to come up with a report on the risks the desks are running with a short position in these bonds versus nominal.Fell a bit stumped at the moment..any suggestions greatly appreciated. Thank you

Well, if you're interested there's a little paper with ir strategy based on IFL here:http://www.cades.fr/en/download/bnpPari ... va.pdfrgds,

QuoteOriginally posted by: WarriorDoes anyone have any ideas on how to risk model Inflation linked bonds? I am looking to come up with a report on the risks the desks are running with a short position in these bonds versus nominal.Fell a bit stumped at the moment..any suggestions greatly appreciated. Thank youThis is an interesting topic. Theoretically, the only inputs are the yield curve and the (expected inflation rate). I controlled an inflation swap book several years ago and UK Index Linked Gilts were used to hedge the RPI positions. To get the forward RPI curve, you would use the gilt prices (several maturities) and bootstrap out a curve using a goal seek method The underlying risks on the book had to be hedged with these gilts and LIBOR. With respect to your problem, I suppose you need to come up with a way of producing actual risk numbers. Looks like you would need an “Inflation Spread” measure (like credit spreads in corp. bonds) ie how much extra yield do you need to take on the Index Linked Risk. Maybe try looking at the prices of an IL bond versus its vanilla version. Let me know what you come up with

And what about CPI publication risk? If your implied forward CPI value is different from the realised one, you get a P&L jump every month...This is similar to LIBOR fixing that happens everyday at noon, but the monthly frequency of CPI publication causes larger jumps.Any comment?CiaoQuoteOriginally posted by: heteroskedasticQuoteOriginally posted by: WarriorDoes anyone have any ideas on how to risk model Inflation linked bonds? I am looking to come up with a report on the risks the desks are running with a short position in these bonds versus nominal.Fell a bit stumped at the moment..any suggestions greatly appreciated. Thank youThis is an interesting topic. Theoretically, the only inputs are the yield curve and the (expected inflation rate). I controlled an inflation swap book several years ago and UK Index Linked Gilts were used to hedge the RPI positions. To get the forward RPI curve, you would use the gilt prices (several maturities) and bootstrap out a curve using a goal seek method The underlying risks on the book had to be hedged with these gilts and LIBOR. With respect to your problem, I suppose you need to come up with a way of producing actual risk numbers. Looks like you would need an “Inflation Spread” measure (like credit spreads in corp. bonds) ie how much extra yield do you need to take on the Index Linked Risk. Maybe try looking at the prices of an IL bond versus its vanilla version. Let me know what you come up with

The TIPS and CPI-U swaps market can provide you more frequent updates, but I've yet to find a way to price any tradable inflation derivative without making a phone call.There is a very limited market for inflation options, based on the difference between interest and principal TIPS strips, but I've found it too be thin and of limited help in getting a broad approximation for vol of inflation and correlation of inflation with other indexes. I will confess to having used historical data when looking at some of these.

Could anyone let me know whether credit risk (same as the credit risk of a corporate bonds) of Italy or Spain who issues inflation linked bonds are monitored by inflation traders? If so, what typically do they do? Thank you.

Not if you trade breakevens, which is the most common inflation position out there... If you're doing a Greek or Italian (Spain doesn't issue linkers; not yet anyways) linker asset swap type of trade, you may have to consider the credit implications, but, in my experience, it's a totally different kettle of fish and, for one, I wouldn't mix the two. So you can hedge credit risk with nominals or CDS, but I haven't seen it done in practice. I suppose it's just a matter of how the inflation portfolio is structured vs the nominal portfolio... Hope it helps.

In practice, linkers are modeled using your regular interest rate dv01 types of measures (calculation of the exact dv01 for a linker, however, is an interesting subject and is much discussed in academia, as far as I know). So, if you're short 100k/bp of 10y TIPS against 10y Trsy, your risk is 100k/bp of 10y breakeven inflation. I don't think it's worth reducing it down any further. If you have 100k/bp of 10y TIPS against 100k/bp of 10y CPI swap, your risk is 100k/bp of 10y TIPS asw. Finally, if you have $100k/bp of 10y TIPS against $100k/bp of 10y vanilla IRS, you have both breakeven inflation risk and asw risk.If you're subsequently trying to model this risk (all those pesky VARs, etc.) you will have to get the time series for the individual components and just do it...Papero, what you're referring to here is the inflation risk proper... There's no CPI fixing risk, at least not the way you describe it.

Hi dkorsunsky, Many thanks for your help.Best Rgds,xdlyn