Finance and Economics Discussion Series (FEDS)
June 2008
Tips from TIPS: the informational content of Treasury Inflation-Protected Security prices
Stefania D'Amico, Don H. Kim, and Min Wei
Abstract:
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.
Full paper (Screen Reader Version)Keywords: Term structure model, inflation expectation, inflation risk premium, SPF, Treasury Inflation-Protected Securities (TIPS)
PDF: Full Paper
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