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

Author

Listed:
  • Josh R. Stillwagon

    (Department of Economics, Trinity College)

Abstract

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.

Suggested Citation

  • Josh R. Stillwagon, 2015. "TIPS and the VIX: Non-linear Spillovers from Financial Panic to Breakeven Inflation," Working Papers 1502, Trinity College, Department of Economics.
    • Handle: RePEc:tri:wpaper:1502
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    File URL: http://www3.trincoll.edu/repec/WorkingPapers2015/WP15-02.pdf
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    References listed on IDEAS

    as
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    Keywords

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    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G01 - Financial Economics - - General - - - Financial Crises
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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