The TIPS Liquidity Premium

TY - JOUR

T1 - The TIPS Liquidity Premium

AU - Andreasen, Martin M.

AU - Christensen, Jens H.E.

AU - Riddell, Simon

N1 - Publisher Copyright: © 2021 The Author(s) 2021. Published by Oxford University Press on behalf of the European Finance Association. All rights reserved.

PY - 2021/11

Y1 - 2021/11

N2 - We introduce an 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 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 helps our model to match TIPS prices. Accounting for liquidity risk also improves the model's ability to forecast inflation and match surveys of inflation expectations.

AB - We introduce an 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 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 helps our model to match TIPS prices. Accounting for liquidity risk also improves the model's ability to forecast inflation and match surveys of inflation expectations.

KW - Financial market frictions

KW - Liquidity risk

KW - Term structure modeling

UR - http://www.scopus.com/inward/record.url?scp=85118531032&partnerID=8YFLogxK

U2 - 10.1093/rof/rfab018

DO - 10.1093/rof/rfab018

M3 - Journal article

AN - SCOPUS:85118531032

SN - 1572-3097

VL - 25

SP - 1639

EP - 1675

JO - Review of Finance

JF - Review of Finance

IS - 6

ER -