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TIPS and the VIX: Non-linear Spillovers from Financial Panic to Breakeven Inflation

Listed author(s):
  • Josh R. Stillwagon

    ()

    (Department of Economics, Trinity College)

This paper examines the determinants of the breakeven inflation rate (BEI) on 5 and 10 year US Treasury inflation protected securities (TIPS). The largest source of variation in BEI has been attributable not to changes in inflation expectations, inflation uncertainty, or liquidity itself, but rather to financial market fear (proxied with the CBOE Volatility Index or VIX). This one variable captures about 60% of the variation in BEI, while the full model adds only 15%. The interpretation is supplemented by decomposing the VIX, using intraday data, into conditional volatility and the variance premium capturing risk aversion. With the exception of the 2008 financial crisis, most of the effect emanated from changes in the variance premium. Lastly, an automated nonlinear modeling approach finds evidence of diminishing returns to liquidity and convex effects of volatility.

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File URL: http://internet2.trincoll.edu/repec/WorkingPapers2015/WP15-02.pdf
File Function: First version, 2015
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Paper provided by Trinity College, Department of Economics in its series Working Papers with number 1502.

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Length: 44 pages
Date of creation: Feb 2015
Handle: RePEc:tri:wpaper:1502
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Web page: http://www.trincoll.edu/Academics/MajorsAndMinors/Economics/Pages/default.aspx

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  1. Castle, Jennifer L. & Hendry, David F., 2009. "The long-run determinants of UK wages, 1860-2004," Journal of Macroeconomics, Elsevier, vol. 31(1), pages 5-28, March.
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  3. Olivier Coibion & Yuriy Gorodnichenko, 2015. "Is the Phillips Curve Alive and Well after All? Inflation Expectations and the Missing Disinflation," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(1), pages 197-232, January.
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  7. Andrew Ang & Geert Bekaert & Min Wei, 2008. "The Term Structure of Real Rates and Expected Inflation," Journal of Finance, American Finance Association, vol. 63(2), pages 797-849, April.
  8. Godfrey, Leslie G, 1978. "Testing for Higher Order Serial Correlation in Regression Equations When the Regressors Include Lagged Dependent Variables," Econometrica, Econometric Society, vol. 46(6), pages 1303-1310, November.
  9. David F. Hendry & Hans-Martin Krolzig, 2004. "We Ran One Regression," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 66(5), pages 799-810, December.
  10. Jonathan H. Wright, 2011. "Term Premia and Inflation Uncertainty: Empirical Evidence from an International Panel Dataset," American Economic Review, American Economic Association, vol. 101(4), pages 1514-1534, June.
  11. David F. Hendry & Hans-Martin Krolzig, 2004. "We Ran One Regression," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 66(5), pages 799-810, December.
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