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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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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 570.

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Length: 62 pages
Date of creation: 2012
Date of revision: 01 Feb 2015
Handle: RePEc:fip:fednsr:570
Note: Previous title: “Pricing TIPS and Treasuries with Linear Regressions”
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  17. Greg Duffee, 2011. "Information in (and not in) the term structure," Economics Working Paper Archive 577, The Johns Hopkins University,Department of Economics.
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