Inflation and the Holding Period Returns on Bonds

Abstract

The relationship between the rate of inflation and the interest rate has been a topic of research for quite some time. A breakthrough in the analysis occurred years ago with Irving Fisher's hypothesis that the nominal interest rate fully reflects the available information concerning the possible future values of the rate of inflation. Others have extended Fisher's original insight to explain further the interaction between the rate of interest and inflation. For example, Mundell [26] uses the Pigou real-balance effect to hypothesize that the real rate of interest is inversely related to the rate of inflation.