The TIPS Liquidity Premium

Martin M. Andreasen, Jens H.E. Christensen, Simon Riddell

Research output: Contribution to journal/Conference contribution in journal/Contribution to newspaperJournal articleResearchpeer-review

1 Citation (Scopus)

Abstract

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.

Original languageEnglish
JournalReview of Finance
Volume25
Issue6
Pages (from-to)1639-1675
Number of pages37
ISSN1572-3097
DOIs
Publication statusPublished - Nov 2021

Keywords

  • Financial market frictions
  • Liquidity risk
  • Term structure modeling

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