Why Does the Treasury Issue TIPS? The TIPS-Treasury Bond Puzzle

Hanno Lustig

No 1443, 2011 Meeting Papers from Society for Economic Dynamics

Abstract: We show that the price of a Treasury bond and an inflation-swapped TIPS issue exactly replicating the cash flows of the Treasury bond can differ by more than $20 per $100 notional. Treasury bonds are almost always overvalued relative to TIPS. Total TIPS-Treasury mispricing has exceeded $56 billion, representing nearly eight percent of the total amount of TIPS outstanding. TIPS-Treasury mispricing is strongly related to supply factors such as Treasury debt issuance and the availability of collateral in the financial markets, and is correlated with other types of fixed-income arbitrages, These results pose a major puzzle to classical asset pricing theory. In addition, they raise the issue of why the Treasury issues TIPS, since in so doing it both gives up a valuable fiscal hedging option and leaves large amounts of money on the table.

Date: 2011
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Working Paper: Why Does the Treasury Issue Tips? The Tips-Treasury Bond Puzzle (2010)
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