Review of Finance Vol. 20 No. 3 2016
Pricing Deflation Risk with US Treasury Yields
Abstract
We use an arbitrage-free term structure model with spanned stochastic volatility to determine the value of the deflation protection option embedded in Treasury inflation-protected securities. The model accurately prices the deflation protection option prior to the financial crisis when its value was near zero; at the peak of the crisis in late 2008 when deflationary concerns spiked sharply; and in the post-crisis period. During 2009, the average value of this option at the 5-year maturity was 41 basis points on a par-yield basis. The option value is shown to be closely linked to overall market uncertainty as measured by the VIX, especially during and after the 2008 financial crisis.
- DOI
- 10.1093/rof/rfv029
- Volume
- 20
- Issue
- 3
- Pages
- 1107-1152
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref