The TIPS Liquidity Premium*

Decomposing real and nominal yield curves

Martin M Andreasen, Jens H E Christensen and Simon Riddell

Review of Finance, 2021, vol. 25, issue 6, 1639-1675

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.

Keywords: Term structure modeling; Liquidity risk; Financial market frictions (search for similar items in EconPapers)
JEL-codes: E43 E47 G12 G13 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (10)

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