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Understanding The Real Rate Conundrum: An Application Of No-Arbitrage Finance Models To The UK Real Yield Curve

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Executive Summary

Long-horizon interest rates in the major international bond markets fell sharply during 2004 and 2005, at the same time as US policy rates were rising; a phenomenon famously described as a 'Conundrum' by Alan Greenspan the Federal Reserve Chairman. But it was arguably the decline in international long real rates over this period which was more unusual and, by the end of 2007; long real rates in the United Kingdom remained at recent historical lows. In this paper, the authors try to shed light on the recent behavior of long real rates, by estimating several empirical models of the term structure of real interest rates, derived from UK index-linked bonds.

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