Can anyone give some color around why the 1-yr treas note uses the long term inflation rate in the risk premium approach instead of the current inflation rate?
Even the text states that the inflation premium should reflect the average inflation expected over the maturity of the debt.
I’m not sure why were using a long term rate for 1 yr debt.
Sure, But I would think current Inflation would more accurately represent next year’s expectations than a long term inflation rate. Am I thinking about this incorrectly, is the inflation from one period to the next completely uncorrelated?
From a Capital markets expectation perspective - a longer term - (I believe they use 12-15 years) is more reasonable… So the long term rate should be used.
Follow up question: any thoughts as to why the 10 year MBS doesn’t include the 1% premium for spread of 10 year over 1 year treasury note? The only premium shown is the 10 year MBS prepayment risk spread, but that’s over 10 year treasuries.
For the MBS, there is a subnote that says it’s a govn’t backed MBS (think GNMA) so there is no spread over the 10yr Treas. Which leaves, Rf, inflation and prepayment spreads.
I get why there isn’t a spread over the 10 year treasury, but shouldn’t they include the spread for the 10 year treasury over the 1 year treasury? Otherwise you’re not being compensated for the extended holding period.