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Why Does the Treasury Issue TIPS? The TIPS-Treasury Bond Puzzle

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  • Hanno Lustig

    (Anderson School of Business)

Abstract

We show that the price of a Treasury bond and an inflation-swapped TIPS issue exactly replicating the cash flows of the Treasury bond can differ by more than $20 per $100 notional. Treasury bonds are almost always overvalued relative to TIPS. Total TIPS-Treasury mispricing has exceeded $56 billion, representing nearly eight percent of the total amount of TIPS outstanding. TIPS-Treasury mispricing is strongly related to supply factors such as Treasury debt issuance and the availability of collateral in the financial markets, and is correlated with other types of fixed-income arbitrages, These results pose a major puzzle to classical asset pricing theory. In addition, they raise the issue of why the Treasury issues TIPS, since in so doing it both gives up a valuable fiscal hedging option and leaves large amounts of money on the table.

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Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 1443.

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Date of creation: 2011
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Handle: RePEc:red:sed011:1443

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Cited by:
  1. Fontana, Alessandro & Scheicher, Martin, 2010. "An analysis of euro area sovereign CDS and their relation with government bonds," Working Paper Series 1271, European Central Bank.
  2. Bauer, Michael D., 2014. "Inflation expectations and the news," Working Paper Series 2014-9, Federal Reserve Bank of San Francisco.
  3. Yuriy Kitsul & Jonathan H. Wright, 2012. "The Economics of Options-Implied Inflation Probability Density Functions," NBER Working Papers 18195, National Bureau of Economic Research, Inc.
  4. Michael J. Fleming & Neel Krishnan, 2009. "The microstructure of the TIPS market," Staff Reports 414, Federal Reserve Bank of New York.
  5. Hongjun Yan & Jinfan Zhang & Dong Lou, 2011. "Anticipated and Repeated Shocks in Liquid Markets," FMG Discussion Papers dp684, Financial Markets Group.
  6. Iryna Kaminska & Dimitri Vayanos & Gabriele Zinna, 2011. "Preferred-Habitat Investors and the US Term Structure of Real Rates," FMG Discussion Papers dp674, Financial Markets Group.
  7. Jens H.E. Christensen & James M. Gillan, 2011. "A model-independent maximum range for the liquidity correction of TIPS yields," Working Paper Series 2011-16, Federal Reserve Bank of San Francisco.
  8. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2011. "The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy," NBER Working Papers 17555, National Bureau of Economic Research, Inc.
  9. Cartea, Álvaro & Saúl, Jonatan & Toro, Juan, 2012. "Optimal portfolio choice in real terms: Measuring the benefits of TIPS," Journal of Empirical Finance, Elsevier, vol. 19(5), pages 721-740.
  10. Robert Engle & Michael Fleming & Eric Ghysels & Giang Nguyen, 2012. "Liquidity, volatility, and flights to safety in the U.S. treasury market: evidence from a new class of dynamic order book models," Staff Reports 590, Federal Reserve Bank of New York.
  11. Stijn Van Nieuwerburgh & Hanno Lustig & Bryan Kelly, 2011. "Too-Systemic-To-Fail: What Option Markets Imply About Sector-wide Government Guarantees," 2011 Meeting Papers 1285, Society for Economic Dynamics.
  12. Jonathan Wright & Yuriy Kitsul, 2012. "The Economics of Options-Implied Inflation Probability Density Functions," 2012 Meeting Papers 174, Society for Economic Dynamics.
  13. John H. Cochrane, 2011. "Discount Rates," NBER Working Papers 16972, National Bureau of Economic Research, Inc.
  14. 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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