Why Does the Treasury Issue TIPS? The TIPS-Treasury Bond Puzzle

81 Pages Posted: 7 Sep 2010 Last revised: 24 Aug 2012

Matthias Fleckenstein

University of California, Los Angeles (UCLA) - Anderson School of Management

Francis A. Longstaff

University of California, Los Angeles (UCLA) - Finance Area; National Bureau of Economic Research (NBER)

Hanno N. Lustig

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Date Written: September 6, 2010

Abstract

We show that the price of a Treasury bond and an inflation-swapped TIPS issue exactly replicating the cash flows of the Treasury bond can differ by more than \$20 per \$100 notional. Treasury bonds are almost always overvalued relative to TIPS. Total TIPS–Treasury mispricing has exceeded \$56 billion, representing nearly 8\% of the total amount of TIPS outstanding. We find direct evidence that the mispricing narrows as additional capital flows into the markets. This provides strong support for the slow-moving-capital explanation of the persistence of arbitrage

Keywords: Fixed Income, Arbitrage, TIPS

JEL Classification: G12

Suggested Citation

Fleckenstein, Matthias and Longstaff, Francis A. and Lustig, Hanno N., Why Does the Treasury Issue TIPS? The TIPS-Treasury Bond Puzzle (September 6, 2010). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1672982 or http://dx.doi.org/10.2139/ssrn.1672982

Matthias Fleckenstein

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Francis A. Longstaff (Contact Author)

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-2218 (Phone)
310-206-5455 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Hanno N. Lustig

Stanford Graduate School of Business ( email )

Stanford GSB
655 Knight Way
Stanford, CA California 94305-6072
United States
3108716532 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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