Working Paper

The TIPS Liquidity Premium

Abstract: We introduce a new arbitrage-free term structure model of nominal and real yields that accounts for liquidity risk in Treasury inflation-protected securities (TIPS). The novel feature of our model is to identify liquidity risk directly from individual TIPS prices by accounting for the tendency that TIPS, like most fixed-income securities, go into buy-and-hold investors? portfolios as time passes. We find a sizable and countercyclical TIPS liquidity premium, which greatly helps our model in matching TIPS prices. Accounting for liquidity risk also improves the model?s ability to forecast inflation and match inflation surveys, although none of these series are included in the estimation.

JEL Classification: E43; E47; G12; G13;

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Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 2017-05-19

Number: 2017-11

Pages: 50 pages

Note: This version: May 19, 2017.