TIPS and the VIX: Non-linear Spillovers from Financial Panic to Breakeven Inflation

Josh Stillwagon ()

No 1502, Working Papers from Trinity College, Department of Economics

Abstract: This paper examines the determinants of the breakeven inflation rate (BEI) on 5 and 10 year US Treasury inflation protected securities (TIPS). The largest source of variation in BEI has been attributable not to changes in inflation expectations, inflation uncertainty, or liquidity itself, but rather to financial market fear (proxied with the CBOE Volatility Index or VIX). This one variable captures about 60% of the variation in BEI, while the full model adds only 15%. The interpretation is supplemented by decomposing the VIX, using intraday data, into conditional volatility and the variance premium capturing risk aversion. With the exception of the 2008 financial crisis, most of the effect emanated from changes in the variance premium. Lastly, an automated nonlinear modeling approach finds evidence of diminishing returns to liquidity and convex effects of volatility.

Keywords: TIPS; breakeven inflation; VIX; liquidity premia; inflation expectations; automated model selection; non-linearities (search for similar items in EconPapers)
JEL-codes: C22 C52 E43 G01 G12 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2015-02
New Economics Papers: this item is included in nep-fmk and nep-mac
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http://www3.trincoll.edu/repec/WorkingPapers2015/WP15-02.pdf First version, 2015 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:tri:wpaper:1502

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