Staff Working Paper No. 1,028
By Saleem Bahaj, Robert Czech, Sitong Ding and Ricardo Reis
This paper uses transaction-level data on UK inflation swaps to characterise who buys and who sells insurance against higher inflation, and to introduce new measures of expected inflation. We find that this market is segmented: pension funds trade at long maturities, while hedge funds trade at short maturities, with dealer banks serving as the counterparty for both. We propose three novel identification strategies based on heteroskedasticity, granular instrumental variables, and sign restrictions to estimate demand and supply functions and to separate expectations from frictions in segmented financial markets. Expected inflation is more firmly anchored at long maturities than what swap prices indicate, while prices for short maturity swaps are mostly driven by shocks to frictions. Prices in this market absorb new information quickly, and the supply of long maturity inflation protection is very elastic. We find a strong correlation across institutions between their survey‑based expectations and their trading behaviour.
This version was updated in April 2025.
The market for inflation risk