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If USSWIT10 Curncy is the expected average inflation for ten years and the USSWIT5 Curncy is the expected average inflation for five years, I don't know why that formula would tell me what the expected 5 year inflation rate would be 5 years from now. Shouldn't there be some sort of compounding taken into account?

I almost feel like you should have to take ((1+USSWIT10)^10 - (1+USSWIT5)^5)/5. Something like that.

filifunk
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The standard method is 2*USSWIT10 - USSWIT5 which as you say, has no compounding. The compounded version that you attempted should be (1+USSWIT10)^2/((1+USSWIT5). If you experiment with actual market values you will find the two are very similar. The higher inflation rates get, the more potential difference there could be. I assume that the non compounded method has been used for simplicity but you are right, the compounded would be more correct since the USSWIT values are zero coupon swaps by definition.

dm63
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  • I see. Sorry to be dense and basic, but why are you raising to the second power? I just figured 10 since USSWIT10 is an annual number and you want to take that ten years out... – filifunk Apr 12 '22 at 01:55
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    Well it’s really the fifth root of ((1+usswit10)^10/(1+usswit5)^5)). The fifth root just annualizes it. And I forgot to say -1 at the end. – dm63 Apr 12 '22 at 03:15