Review of Finance Vol. 25 No. 6 2021

The TIPS Liquidity Premium

Martin Møller Andreasen¹; Jens H. E. Christensen²; Simon Riddell³

¹ Aarhus University · ² Federal Reserve Bank of San Francisco · ³ Amazon

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.

DOI

10.1093/rof/rfab018

Volume

25

Issue

6

Pages

1639-1675

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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