Tips from TIPS: The Informational Content of Treasury Inflation-Protected Security Prices
Bank for International Settlements, 2008 - Inflation (Finance) - 42 pages
We examine the informational content of TIPS yields from the viewpoint of a general 3-factor no-arbitrage term structure model of inflation and interest rates. Our empirical results indicate that TIPS yields contained a "liquidity premium" that was until recently quite large (1%). Key features of this premium are difficult to account for in a rational pricing framework, suggesting that TIPS may not have been priced efficiently in its early years. Besides the liquidity premium, a time-varying inflation risk premium complicates the interpretation of the TIPS breakeven inflation rate (the difference between the nominal and TIPS yields). Nonetheless, high-frequency variation in the TIPS breakeven rates is similar to the variation in inflation expectations implied by the model, lending support to the view that TIPS breakeven inflation rates are a useful proxy for inflation expectations.
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1-year thin red 10-year breakeven rate 10-year inﬂation expectation 10-year nominal yield 10-year thick blue 10-year TlPS yield afﬁne afﬁne-Gaussian models basis points bond yields breakeven rate thick CPl inﬂation deﬁned delta method difﬁcult expected inﬂation factors ﬁnd Fisher hypothesis ﬁve ﬂexible implied volatility indexed bond inﬂation risk premium inﬂation uncertainty interest rates lnﬂation Risk Premium long-horizon maturity measurement error Michigan survey Model 1-year Model-implied 1-year thin Model-implied 10-year breakeven model-implied real yields no-arbitrage models nominal and real nominal and TlPS nominal bond nominal interest rates Note NT-l and NT-ll NT-ll estimation premia pricing kernel real term premium real term structure reﬂects short rate speciﬁcation stochastic volatility survey forecasts survey inﬂation forecast swaptions T05-ll estimations term structure model thick blue line thin red line Tips from TlPS TlPS breakeven rate TlPS data TlPS liquidity premium TlPS market variables variance decompositions variation vector weekly changes yield curve