The missing piece of the puzzle: Liquidity premiums in inflation-indexed markets

Joost Driessen, Theo E. Nijman and Zorka Simon

No 183, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: Fleckenstein et al. (2014) document that nominal Treasuries trade at higher prices than inflation-swapped indexed bonds, which exactly replicate the nominal cash flows. We study whether this mispricing arises from liquidity premiums in inflation-indexed bonds (TIPS) and inflation swaps. Using US data, we show that the level of liquidity affects TIPS, whereas swap yields include a liquidity risk premium. We also allow for liquidity effects in nominal bonds. These results are based on a model with a systematic liquidity risk factor and asset-specific liquidity characteristics. We show that these liquidity (risk) premiums explain a substantial part of the TIPS underpricing.

Keywords: liquidity premium; liquidity risk; TIPS; inflation swaps; TIPS-Treasury puzzle (search for similar items in EconPapers)
JEL-codes: C51 G01 G12 H63 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:183

DOI: 10.2139/ssrn.3042506

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