The Economic Value of TIPS Arbitrage Mispricing
33 Pages Posted: 27 Jan 2020
Date Written: October 24, 2018
Rational frictionless asset pricing models imply that inflation swap rates and break-even inflation rates with same maturity must be equal. The data, however, suggest a persistent positive difference between these two quantities, which the literature attributes to mispricing of Treasury Inflation-Protected Securities (TIPS). In theory, factors driving TIPS mispricing are not directly observable to the econometrician. To reveal these factors, we analyze the daily term structure of TIPS mispricing and uncover its information content. To assess its economic value, we derive novel high-frequency stylized facts about its dynamics. We document strong relationships with stock market returns, option-implied volatility and variance risk premium, and an important channel for predicting inflation, bond and equity excess returns, jointly.
Keywords: principal component analysis, reduced rank regression, predictability
JEL Classification: G11, G12
Suggested Citation: Suggested Citation