Tips from TIPS: the informational content of Treasury Inflation-Protected Security prices

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. Key features...

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Bibliographic Details
Published in:Policy File 2008
Main Authors: D'Amico, Stefania, Kim, Don H, Wei, Min
Format: Report
Language:English
Subjects:
Bank for International Settlements
Banking/Finance
Economic policy
International/Economic development
Online Access:Request full text
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Summary: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. 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.