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

50 Pages Posted: 13 Sep 2010 Last revised: 13 Mar 2023

See all articles by Matthias Fleckenstein

Matthias Fleckenstein

University of Delaware

Francis A. Longstaff

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

Hanno N. Lustig

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

Date Written: September 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 eight percent of the total amount of TIPS outstanding. TIPS-Treasury mispricing is strongly related to supply factors such as Treasury debt issuance and the availability of collateral in the financial markets, and is correlated with other types of fixed-income arbitrages, These results pose a major puzzle to classical asset pricing theory. In addition, they raise the issue of why the Treasury issues TIPS, since in so doing it both gives up a valuable fiscal hedging option and leaves large amounts of money on the table.

Suggested Citation

Fleckenstein, Matthias and Longstaff, Francis A. and Lustig, Hanno N., Why Does the Treasury Issue Tips? The Tips-Treasury Bond Puzzle (September 2010). NBER Working Paper No. w16358, Available at SSRN: https://ssrn.com/abstract=1674800

Matthias Fleckenstein (Contact Author)

University of Delaware ( email )

419 Purnell Hall
Newark, DE 19716
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3028314936 (Phone)

HOME PAGE: http://www.mfleckenstein.com

Francis A. Longstaff

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

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

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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