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TIPS, Inflation Expectations and the Financial Crisis

Author

Listed:
  • Thorsten Lehnert

    () (Luxembourg School of Finance, University of Luxembourg)

  • Aleksandar Andonov

    (Limburg Institute of Financial Economics, Maastricht University)

  • Florian Bardong

    () (Fixed Income Research, Barclays Global Investors, London)

Abstract

Previous research indicates that the US market for inflation-linked bonds is not efficient and that market inefficiencies can be exploited by informed traders who include survey estimations or inflation model forecasts in trades on break-even inflation. Results from this extended research over a time-period in which the TIPS market matured and increased in depth, while the volatility of real yields and inflation increased, confirm that TIPS market inefficiency was not temporary but persisted over the entire time period between 1997 and 2009. Using estimations generated by the Survey of Professional Forecasters or forecasts based on the Kothari and Shanken (2004) inflation model to construct a break-even trading strategy leads to excess returns over a static buy-and-hold strategy. These excess returns remain substantial even after accounting for trading costs. Furthermore, TIPS returns still include a substantial liquidity premium, which increased during the financial crisis.

Suggested Citation

  • Thorsten Lehnert & Aleksandar Andonov & Florian Bardong, 2009. "TIPS, Inflation Expectations and the Financial Crisis," LSF Research Working Paper Series 09-09, Luxembourg School of Finance, University of Luxembourg.
  • Handle: RePEc:crf:wpaper:09-09
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    File URL: http://www.lsf.lu/eng/content/download/1218/6049/file/09-09.pdf
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    References listed on IDEAS

    as
    1. Giordani, Paolo & Soderlind, Paul, 2003. "Inflation forecast uncertainty," European Economic Review, Elsevier, vol. 47(6), pages 1037-1059, December.
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    4. Nelson, Charles R & Schwert, G William, 1977. "Short-Term Interest Rates as Predictors of Inflation: On Testing the Hypothesis That the Real Rate of Interest is Constant," American Economic Review, American Economic Association, vol. 67(3), pages 478-486, June.
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    7. Charles T. Carlstrom & Timothy S. Fuerst, 2004. "Expected inflation and TIPS," Economic Commentary, Federal Reserve Bank of Cleveland, issue Nov.
    8. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
    9. Florian Bardong & Thorsten Lehnert, 2008. "TIPS and inflation expectations," Applied Economics Letters, Taylor & Francis Journals, vol. 15(7), pages 513-517.
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    More about this item

    Keywords

    TIPS; market; inflation expectations; survey of Professional Forecasters; financial crisis;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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