Pricing TIPS and Treasuries with Linear Regressions

57 Pages Posted: 22 Sep 2012 Last revised: 7 May 2013

See all articles by Michael Abrahams

Michael Abrahams

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Tobias Adrian

International Monetary Fund

Richard K. Crump

Federal Reserve Banks - Federal Reserve Bank of New York

Emanuel Moench

Deutsche Bundesbank; Goethe University Frankfurt - Department of Money and Macroeconomics

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Date Written: April 26, 2013

Abstract

We present an affine term structure model for the joint pricing of TIPS and Treasury yield curves that adjusts for TIPS’ relative illiquidity. Our estimation via linear regressions is computationally efficient and can accommodate a large number of pricing factors. The baseline specification with seven principal components extracted from Treasury and TIPS yields as well as a liquidity factor generates negligibly small pricing errors for both real and nominal yields. Model-implied expected inflation adjusted for risk premia and liquidity provides a better prediction of actual inflation than unadjusted breakeven inflation. Analysis of model-implied Treasury and TIPS decompositions shows that the Federal Reserve’s large-scale asset purchases lowered nominal and real Treasury yields primarily via a reduction of real term premia, the compensation investors demand for bearing real short-rate risk. Real term premia also account for the large response of long-term real forward rates to monetary policy surprises. The deflation floor embedded in TIPS is generally small in magnitude, but spiked during the recent crisis. We also show that the nominal and real term structures from the United Kingdom have qualitatively similar features to the U.S. yields.

Keywords: TIPS, inflation expectations, affine term structure models

JEL Classification: G12, E44

Suggested Citation

Abrahams, Michael and Adrian, Tobias and Crump, Richard K. and Moench, Emanuel, Pricing TIPS and Treasuries with Linear Regressions (April 26, 2013). FRB of New York Staff Report No. 570, Available at SSRN: https://ssrn.com/abstract=2150327 or http://dx.doi.org/10.2139/ssrn.2150327

Michael Abrahams

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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United States

Tobias Adrian (Contact Author)

International Monetary Fund ( email )

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Washington, DC 20431
United States

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

Richard K. Crump

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Emanuel Moench

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany
+49 69 95662312 (Phone)

HOME PAGE: http://https://www.bundesbank.de/en/emanuel-moench

Goethe University Frankfurt - Department of Money and Macroeconomics ( email )

Germany

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