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TIPS: Taking Inflation Premium Seriously

Author

Listed:
  • Min Wei
  • Stefania D'Amico
  • Don H. Kim

Abstract

This paper asks the question of whether the newly available TIPS yields data can help us achieve a better understanding of the real term structure and the inflation expectations. The yield differential between TIPS and comparable nominal coupon securities is not a direct measure of inflation expectations, because it contains inflation risk premium, and because the TIPS yield may depart from the true "real yield," due to low investor demand especially in the early years. Without using data from the (indexed) real bond market, we cannot fully identify the real interest rate from the inflation risk premium, unless we assume that all information affecting the real term structure is reflected in the nominal bond prices. Even with this assumption, empirical identification of the real term structure is hard to achieve because of the poor measurement and the frequent revisions of the price series. We develop a flexible multifactor term-structure model to allow for suitable specifications of liquidity premium on TIPS, as well as complications caused by lagged indexation. We estimate the model by the Kalman filter using TIPS yields, nominal bond yields, realized inflation and survey data on interest rates and inflation

Suggested Citation

  • Min Wei & Stefania D'Amico & Don H. Kim, 2005. "TIPS: Taking Inflation Premium Seriously," Computing in Economics and Finance 2005 363, Society for Computational Economics.
    • Handle: RePEc:sce:scecf5:363
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    File URL: http://repec.org/sce2005/up.17868.1107201691.pdf
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    Cited by:

    1. Wändi Bruine de Bruin & Michael F. Bryan & Simon M. Potter & Giorgio Topa & Wilbert Van der Klaauw, 2008. "Rethinking the measurement of household inflation expectations: preliminary findings," Staff Reports 359, Federal Reserve Bank of New York.
    2. Steve Ambler, 2009. "Price‐Level Targeting And Stabilisation Policy: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 23(5), pages 974-997, December.

    More about this item

    Keywords

    TIPS; Inflation risk premium; term structure of interest rates;
    All these keywords.

    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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