Why Does the Treasury Issue Tips? The Tips–Treasury Bond Puzzle

Matthias Fleckenstein, Francis A. Longstaff, Hanno Lustig

NBER Working Paper No. 16358
Issued in September 2010
NBER Program(s):   AP   ME

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.

An NBER digest for this paper is available.

You may purchase this paper on-line in .pdf format from SSRN.com ($5) for electronic delivery.

Acknowledgments

Machine-readable bibliographic record - MARC, RIS, BibTeX