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

  • Hanno Lustig

    (Anderson School of Business)

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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File URL: https://economicdynamics.org/meetpapers/2011/paper_1443.pdf
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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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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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