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A model-independent maximum range for the liquidity correction of TIPS yields

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  • Jens H.E. Christensen
  • James M. Gillan

Abstract

We derive a model-independent maximum range for the admissible liquidity risk premium in real Treasury bonds—also known as Treasury Inflation Protected Securities (TIPS). The range is constructed using additional information in the inflation swap market and a set of simple theoretical assumptions. As an application, we construct a lower bound to estimates of the inflation risk premium the Treasury receives from TIPS by deducting their maximum liquidity premium. This conservative measure of the benefit to the Treasury of issuing TIPS is positive on average at the ten-year maturity for our sample period.

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File URL: http://www.frbsf.org/publications/economics/papers/2011/wp11-16bk.pdf
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Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2011-16.

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Date of creation: 2011
Date of revision:
Handle: RePEc:fip:fedfwp:2011-16

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Keywords: Inflation (Finance) ; Inflation-indexed bonds;

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References

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  1. Jens H.E. Christensen & Francis X. Diebold & Glenn D. Rudebusch, 2007. "The affine arbitrage-free class of Nelson-Siegel term structure models," Working Paper Series 2007-20, Federal Reserve Bank of San Francisco.
  2. Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2008. "Inflation expectations and risk premiums in an arbitrage-free model of nominal and real bond yields," Working Paper Series 2008-34, Federal Reserve Bank of San Francisco.
  3. Tobias Adrian & Hao Wu, 2009. "The term structure of inflation expectations," Staff Reports 362, Federal Reserve Bank of New York.
  4. Matthias Fleckenstein & Francis A. Longstaff & Hanno Lustig, 2010. "Why Does the Treasury Issue Tips? The Tips–Treasury Bond Puzzle," NBER Working Papers 16358, National Bureau of Economic Research, Inc.
  5. Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2011. "Extracting deflation probability forecasts from Treasury yields," Working Paper Series 2011-10, Federal Reserve Bank of San Francisco.
  6. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October.
  7. Michael J. Fleming & Bruce Mizrach, 2009. "The microstructure of a U.S. Treasury ECN: the BrokerTec platform," Staff Reports 381, Federal Reserve Bank of New York.
  8. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
  9. Michael J. Fleming, 2003. "Measuring treasury market liquidity," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 83-108.
  10. Brian Sack & Robert Elsasser, 2004. "Treasury inflation-indexed debt: a review of the U.S. experience," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 47-63.
  11. Joyce, Michael & Lildholdt, Peter & Sorensen, Steffen, 2009. "Extracting inflation expectations and inflation risk premia from the term structure: a joint model of the UK nominal and real yield curves," Bank of England working papers 360, Bank of England.
  12. Carolin E. Pflueger & Luis M. Viceira, 2011. "Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity," NBER Working Papers 16892, National Bureau of Economic Research, Inc.
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Cited by:
  1. Carolin E. Pflueger & Luis M. Viceira, 2011. "Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity," Harvard Business School Working Papers 11-094, Harvard Business School, revised Sep 2013.
  2. Jens H.E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2012. "Pricing deflation risk with U.S. Treasury yields," Working Paper Series 2012-07, Federal Reserve Bank of San Francisco.
  3. Bruno Feunou & Jean-Sébastien Fontaine, 2012. "Forecasting Inflation and the Inflation Risk Premiums Using Nominal Yields," Working Papers 12-37, Bank of Canada.

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