Decomposing real and nominal yield curves
We present an affine term structure model for the joint pricing of Treasury Inflation-Protected Securities (TIPS) and Treasury yield curves that adjusts for TIPS’ relative illiquidity. Our estimation using linear regressions is computationally very fast and can accommodate unspanned factors. The baseline specification with six principal components extracted from Treasury and TIPS yields, in combination with a liquidity factor, generates negligibly small pricing errors for both real and nominal yields. Model-implied expected inflation provides a better prediction of actual inflation than breakeven inflation. The value of the deflation floor calculated from the model is generally small in magnitude, but spiked during the recent crisis.
|Date of creation:||2012|
|Date of revision:||01 Feb 2015|
|Note:||Previous title: “Pricing TIPS and Treasuries with Linear Regressions”|
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- Adrian, Tobias & Crump, Richard K. & Moench, Emanuel, 2013.
"Pricing the term structure with linear regressions,"
Journal of Financial Economics,
Elsevier, vol. 110(1), pages 110-138.
- Tobias Adrian & Emanuel Moench, 2008. "Pricing the term structure with linear regressions," Staff Reports 340, Federal Reserve Bank of New York.
- Olesya V. Grishchenko & Jing-zhi Huang, 2012. "Inflation risk premium: evidence from the TIPS market," Finance and Economics Discussion Series 2012-06, Board of Governors of the Federal Reserve System (U.S.).
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