Tips from TIPS: The Informational Content of Treasury Inflation-Protected Security Prices

69 Pages Posted: 20 Mar 2007 Last revised: 7 Jan 2010

See all articles by Stefania D'Amico

Stefania D'Amico

Federal Reserve Bank of Chicago

Don H. Kim

Board of Governors of the Federal Reserve System

Min Wei

Board of Governors of the Federal Reserve System

Date Written: December 29, 2009

Abstract

TIPS breakeven inflation rate, defined as the difference between nominal and TIPS yields of comparable maturities, is potentially useful as a real-time measure of market inflation expectations. In this paper, we provide evidence that a fairly large TIPS liquidity premium existed until recently, using a multifactor no-arbitrage term structure model estimated with nominal and TIPS yields, inflation and survey forecasts of interest rates. Ignoring the TIPS liquidity premiums leads to counterintuitive implications for inflation expectations and inflation risk premium, and produces large pricing errors for TIPS. In contrast, models incorporating a TIPS liquidity factor generate much better fit for these variables and reveal a TIPS liquidity premium that was until recently quite large (~1%) but has come down in recent years, consistent with the common perception that TIPS market grew and liquidity conditions improved. Our results indicate that after taking proper account of the liquidity conditions in the TIPS market, the movement in TIPS breakeven inflation rate can provide useful information for identifying real yields, expected inflation and inflation risk premium.

Keywords: Term structure model, Inflation expectation, Inflation risk premium, SPF, Treasury Inflation-Protected Securities (TIPS)

JEL Classification: G12, E31, E43

Suggested Citation

D'Amico, Stefania and Kim, Don H. and Wei, Min, Tips from TIPS: The Informational Content of Treasury Inflation-Protected Security Prices (December 29, 2009). AFA 2008 New Orleans Meetings Paper, Available at SSRN: https://ssrn.com/abstract=960869 or http://dx.doi.org/10.2139/ssrn.960869

Stefania D'Amico

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Don H. Kim

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Min Wei (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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