Pricing deflation risk with U.S. Treasury yields
AbstractWe use an arbitrage-free term structure model with spanned stochastic volatility to determine the value of the deflation protection option embedded in Treasury inflation-protected securities (TIPS). The model accurately prices the deflation protection option prior to the financial crisis when its value was near zero; at the peak of the crisis in late 2008 when deflationary concerns spiked sharply; and in the post-crisis period. During 2009, the average value of this option at the five-year maturity was 41 basis points on a par-yield basis.
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Bibliographic InfoPaper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2012-07.
Date of creation: 2012
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-06-13 (All new papers)
- NEP-CBA-2012-06-13 (Central Banking)
- NEP-MAC-2012-06-13 (Macroeconomics)
- NEP-MON-2012-06-13 (Monetary Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Chernov, Mikhail & Mueller, Philippe, 2008.
"The Term Structure of Inflation Expectations,"
CEPR Discussion Papers
6809, C.E.P.R. Discussion Papers.
- Yuriy Kitsul & Jonathan H. Wright, 2012. "The Economics of Options-Implied Inflation Probability Density Functions," Economics Working Paper Archive 600, The Johns Hopkins University,Department of Economics.
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