The Missing Piece of the Puzzle

Liquidity Premiums in Inflation-Indexed Markets

Research output: Working paperOther research output

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.
Original languageEnglish
PublisherSSRN
Number of pages52
DOIs
Publication statusPublished - 2017

Publication series

NameSAFE Working Paper
Volume183

Fingerprint

Liquidity risk
Inflation
Liquidity premium
Liquidity
Risk premium
Swaps
Risk factors
Assets
Mispricing
Underpricing
Cash flow
Liquidity effect

Keywords

  • liquidity premium
  • liquidity risk
  • TIPS
  • inflation swaps
  • TIPS-treasury puzzle

Cite this

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title = "The Missing Piece of the Puzzle: Liquidity Premiums in Inflation-Indexed Markets",
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.",
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The Missing Piece of the Puzzle : Liquidity Premiums in Inflation-Indexed Markets. / Driessen, Joost; Nijman, Theo; Simon, Z.

SSRN, 2017. (SAFE Working Paper; Vol. 183).

Research output: Working paperOther research output

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AB - 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.

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