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Decomposing real and nominal yield curves

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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.

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  • Abrahams, Michael & Adrian, Tobias & Crump, Richard K. & Moench, Emanuel, 2012. "Decomposing real and nominal yield curves," Staff Reports 570, Federal Reserve Bank of New York, revised 01 Feb 2015.
  • Handle: RePEc:fip:fednsr:570
    Note: Previous title: “Pricing TIPS and Treasuries with Linear Regressions”
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    Cited by:

    1. Jonathan Hambur & Richard Finlay, 2018. "Affine Endeavour: Estimating a Joint Model of the Nominal and Real Term Structures of Interest Rates in Australia," RBA Research Discussion Papers rdp2018-02, Reserve Bank of Australia.
    2. Abrahams, Michael & Adrian, Tobias & Crump, Richard K. & Moench, Emanuel & Yu, Rui, 2016. "Decomposing real and nominal yield curves," Journal of Monetary Economics, Elsevier, vol. 84(C), pages 182-200.
    3. repec:eee:jimfin:v:74:y:2017:i:c:p:337-352 is not listed on IDEAS
    4. Stavrakeva, Vania & Tang, Jenny, 2016. "Exchange rates and the yield curve," Working Papers 16-21, Federal Reserve Bank of Boston.
    5. Martin Kliem & Alexander Meyer-Gohde, 2017. "(Un)expected Monetary Policy Shocks and Term Premia," SFB 649 Discussion Papers SFB649DP2017-015, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    6. Lange, Ronald H., 2017. "The expected real yield and inflation components of the nominal yield curve," The North American Journal of Economics and Finance, Elsevier, vol. 39(C), pages 1-18.
    7. repec:fip:fedker:00048 is not listed on IDEAS
    8. repec:kap:rqfnac:v:50:y:2018:i:3:d:10.1007_s11156-017-0643-z is not listed on IDEAS
    9. Hanson, Samuel & Lucca, David O. & Wright, Jonathan H., 2017. "Interest rate conundrums in the twenty-first century," Staff Reports 810, Federal Reserve Bank of New York.
    10. Martin M. Andreasen & Jens H.E. Christensen & Simon Riddell, 1508. "The TIPS Liquidity Premium," CREATES Research Papers 2017-27, Department of Economics and Business Economics, Aarhus University.
    11. Kano, Takashi & Wada, Kenji, 2017. "The first arrow hitting the currency target: A long-run risk perspective," Journal of International Money and Finance, Elsevier, vol. 74(C), pages 337-352.

    More about this item

    Keywords

    TIPS; break-evens; expected inflation; inflation risk premium; affine term-structure model; liquidity risk;

    JEL classification:

    • 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
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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