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Tips from TIPS: The Informational Content of Treasury Inflation-Protected Security Prices

Published online by Cambridge University Press:  14 February 2018

Stefania D’Amico ,
Don H. Kim  and
Min Wei
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Abstract

Treasury Inflation-Protected Securities (TIPS) are frequently thought of as risk-free real bonds. Using no-arbitrage term structure models, we show that TIPS yields exceeded risk-free real yields by as much as 100 basis points when TIPS were first issued and up to 300 basis points during the 2007–2008 financial crisis. This spread predominantly reflects the poorer liquidity of TIPS relative to nominal Treasury securities. Other factors, including the indexation lag and the embedded deflation protection in TIPS, play a much smaller role. Ignoring this spread also significantly distorts the informational content of TIPS break-even inflation, a widely used proxy for expected inflation.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 53 , Issue 1 , February 2018 , pp. 395 - 436
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

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Footnotes

1

Part of the work on this article was done while Kim was at the Bank for International Settlements. We thank Andrew Ang, Geert Bekaert, Hendrik Bessembinder (the editor), Ruslan Bikbov, Claudio Borio, Seamus Brown, Mike Chernov, Jim Clouse, Greg Duffee, Matthias Fleckenstein (the referee), Campbell Harvey, Peter Hördahl, Mike Joyce, ChiragMirani, Athanasios Orphanides, Frank Packer, George Pennacchi, Jennifer Roush, Brian Sack, Jonathan Wright, and seminar participants at the 2005 International Conference on Computing in Economics and Finance, the 2006 European Central Bank Workshop on Inflation Risk Premium, the 2007 Dallas Fed Conference on Price Measurement for Monetary Policy, the 2008 American Finance Association Annual Meetings, and the San Francisco Fed for helpful comments or discussions. This work is based in large part on data constructed by current and previous members of the Monetary and Financial Markets Analysis Section in the Monetary Affairs Division of the Federal Reserve Board of Governors, to whom we are grateful. We alone are responsible for any errors. The opinions expressed in this paper do not necessarily reflect those of the Federal Reserve Board or the Federal Reserve System or the Bank for International Settlements.

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