The Missing Piece of the Puzzle: Liquidity Premiums in Inflation-Indexed Markets

52 Pages Posted: 26 Sep 2017

See all articles by Joost Driessen

Joost Driessen

Tilburg University - Center and Faculty of Economics and Business Administration; Tilburg University - Center for Economic Research (CentER)

Theo Nijman

Tilburg University - Center and Faculty of Economics and Business Administration

Zorka Simon

Goethe University Frankfurt - Research Center SAFE; Netspar

Multiple version iconThere are 2 versions of this paper

Date Written: September 25, 2017

Abstract

Fleckenstein et al. (2014) document that nominal Treasuries trade at higher prices than inflation-swapped indexed bonds, which exactly replicate the nominal cash flows. We study whether this mispricing arises from liquidity premiums in inflation-indexed bonds (TIPS) and inflation swaps. Using US data, we show that the level of liquidity affects TIPS, whereas swap yields include a liquidity risk premium. We also allow for liquidity effects in nominal bonds. These results are based on a model with a systematic liquidity risk factor and asset-specific liquidity characteristics. We show that these liquidity (risk) premiums explain a substantial part of the TIPS underpricing.

Keywords: Liquidity premium, liquidity risk, TIPS, inflation swaps, TIPS–Treasury puzzle

JEL Classification: C51, G12, G01, H63

Suggested Citation

Driessen, Joost and Nijman, Theo E. and Simon, Zorka, The Missing Piece of the Puzzle: Liquidity Premiums in Inflation-Indexed Markets (September 25, 2017). SAFE Working Paper No. 183. Available at SSRN: https://ssrn.com/abstract=3042506 or http://dx.doi.org/10.2139/ssrn.3042506

Joost Driessen

Tilburg University - Center and Faculty of Economics and Business Administration ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Theo E. Nijman

Tilburg University - Center and Faculty of Economics and Business Administration ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2342 (Phone)
+31 13 466 3280 (Fax)

Zorka Simon (Contact Author)

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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