The Economic Value of TIPS Arbitrage Mispricing

33 Pages Posted: 27 Jan 2020

Date Written: October 24, 2018

Abstract

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

Dedes, Vasilis and Tédongap, Roméo, The Economic Value of TIPS Arbitrage Mispricing (October 24, 2018). Available at SSRN: https://ssrn.com/abstract=3512853 or http://dx.doi.org/10.2139/ssrn.3512853

Vasilis Dedes (Contact Author)

BlackRock, Inc

London
United Kingdom

Roméo Tédongap

ESSEC Business School ( email )

Avenue Bernard Hirsch
BP 105 Cergy Cedex, 95021
France
+33134439734 (Phone)
+33134439734 (Fax)

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