The Informational Content of the Embedded Deflation Option in TIPS
80 Pages Posted: 16 Sep 2012 Last revised: 23 Dec 2015
Date Written: October 23, 2015
We estimate the value of the embedded option in the U.S. Treasury Inflation Protected Securities (TIPS). The embedded option value exhibits time variation that is correlated with periods of deflationary expectations. We construct embedded option explanatory variables that are statistically and economically significant for explaining future inflation, even in the presence of traditional inflation variables such as lagged inflation, the gold return, the crude oil return, the VIX return, liquidity, surveys, and the yield spread between nominal Treasuries and TIPS. After conducting robustness tests, we conclude that the TIPS embedded option contains useful information for future inflation.
Keywords: TIPS, embedded option, inflation, deflation, term structure
JEL Classification: E31, G12, E43, E44
Suggested Citation: Suggested Citation