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The TIPS Liquidity Premium

Martin M. Andreasen (), Jens H.E. Christensen () and Simon Riddell ()
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Martin M. Andreasen: Aarhus University and CREATES, Postal: Department of Economics and Business Economics, Fuglesangs Allé 4, 8210 Aarhus V, Denmark
Jens H.E. Christensen: Federal Reserve Bank of San Francisco, Postal: Federal Reserve Bank of San Francisco, 101 Market Street MS 1130, San Francisco, CA 94105, USA
Simon Riddell: Amazon

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

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 greatly helps our model in matching TIPS prices. Accounting for liquidity risk also improves the model's ability to forecast inflation and match inflation surveys, although none of these series are included in the estimation.

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: 2017-08-15
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