Analysing and Interpreting the Yield Curve, 2nd Edition

CHAPTER 7The Index‐Linked Bond Yield Curve

Bonds that have part or all of their cash flows linked to an inflation index form an important segment of several government bond markets. In the UK, the first sovereign index‐linked bonds were issued in 1981 and at the end of 2018 they accounted for approximately 20% of outstanding nominal value in the gilt market. Index‐linked bonds have also been issued in the US Treasury market and in Australia, Canada, the Netherlands, New Zealand and Sweden. There is no uniformity in market structure and as such there are significant differences between the index‐linked markets in these countries. There is also a wide variation in the depth and liquidity of these markets.

Index‐linked bonds or inflation‐indexed bonds present additional issues in their analysis, due to the nature of their cash flows. Measuring the return on index‐linked bonds is less straightforward than with conventional bonds, and in certain cases there are peculiar market structures that must be taken into account as well. For example, in the US index‐linked Treasuries market (known as “TIPS” from Treasury inflation‐indexed securities), there is no significant lag between the inflation link and the cash flow payment date. In the UK, there is an eight‐month lag between the inflation adjustment of the cash flow and the cash flow payment date itself (changed to a three‐month lag for bonds issued from 2005), while in New Zealand there is a three‐month lag. The existence of a lag ...