Inflation Modeling Revisited: Modeling a Complex Market
Risk practitioners take great care in preparing for every possibility the future might hold, and yet many economic models still failed to capture the 2021 inflation episode. Some of this can be attributed to recency bias, but the technical challenges of realistically modeling inflation rates also likely played a part.
In part two of our series on inflation, we look at how inflation and inflation markets should be approached within the context of modeling within an economic scenario generator. We discuss the two key factors of model performance, target setting and model structure, as well as the importance—and challenges—of parameterizing with adequate historical data