The information content of the embedded deflation pption in TIPS

Olesya Grishchenko, Joel M. Vanden and Jianing Zhang

No 2011-58, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: In this paper we estimate the value of the embedded option in U.S. Treasury Inflation Protected Securities (TIPS). The option value exhibits significant time variation that is correlated with periods of deflationary expectations. We use our estimated option values to construct an embedded option price index and an embedded option return index. We then use our embedded option indices as independent variables and examine their statistical and economic significance for explaining the future inflation rate. In most of our regressions, our embedded option return index is significant even in the presence of traditional inflation variables, such as the yield spread between nominal Treasuries and TIPS, the return on gold bullion, the VIX index return, and the lagged inflation rate. We conduct several robustness tests, including alternative weighting schemes, alternative variable specifications, and alternative data samples. We conclude that the embedded option in TIPS contains useful information for future inflation, both in-sample and out-of-sample. Our results should be valuable to practitioners, monetary authorities, and policymakers alike.

Keywords: Inflation (Finance); Forecasting; Inflation-indexed bonds - United States; Government securities - United States (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-cba
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Citations: View citations in EconPapers (8)

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