Real risk, inflation risk, and the term structure

I present a model for the term structures of nominal and real interest rates in the UK that incorporates Markov-switching and allows for non-neutralities, nonlinear dynamics, and flexibility in the dynamics of the risk premia. The model is used to assess how accurately the term structure reflects changing expectations of future yields and inflation. I find that variations in inflation expected over the next two to three years are very accurately reflected by current yields. Over longer horizons, the term structures closely track changing expectations regarding future nominal and real yields but not future inflation.