TIPS Liquidity Premium and Quantitative Easing

Abstract

We assess the effect of the QE2 program on the TIPS liquidity premium using a latent factor approach and a counterfactual exercise. In the context of a state-space model for nominal and TIPS yields, we identify the TIPS liquidity premium as the common component in TIPS yields that is unspanned by nominal yields. We then construct a counterfactual TIPS liquidity premium that exploits suitable conditioning information. Results indicate that the QE2 program had only limited effect on the TIPS liquidity premium.

Keywords: TIPS, Liquidity Premium, Factor Models, Quantitative Easing

JEL Classification: C33, C53, E43, G12