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Swapping Headline for Core Inflation: An Asset Liability Management Approach

Headline Inflation in the US has been shown to be mean reverting to Core Inflation at medium term, whilst at the same time the pass-through of commodity prices shocks from the headline to the core has dramatically gone down. It yields lower relative volatility for the latter and creates a drive for investing in commodities as a hedge. In this paper we argue for a risk reduction in ALM strategy in the form of a shift from targeting core rather than headline inflation for long term hedgers while proposing an overlaying swap to hedge the potential performance gap. A market curve for core inflation could be derived from the trading of these swaps and enable easy mark-to-market valuation of these securities in balance sheets. Any supply and demand market disequilibrium between long term sellers of headline inflation and short term sellers of core inflation could be matched by the intermediation of market makers which could price the derivative based on the cross hedging potential of commodities.

FULLI-LEMAIRE Nicolas , Research Analyst – Investor Research Centre at Amundi

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Swapping Headline for Core Inflation: An Asset Liability Management Approach
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