UCLA Anderson School of Management
110 Westwood Plaza
NBER Working Papers and Publications
|July 2013||Deflation Risk|
with Francis A. Longstaff, Hanno Lustig: w19238
We study the nature of deflation risk by extracting the objective distribution of inflation from the market prices of inflation swaps and options. We find that the market expects inflation to average about 2.5 percent over the next 30 years. Despite this, the market places substantial probability weight on deflation scenarios in which prices decline by more than 10 to 20 percent over extended horizons. We find that the market prices the economic tail risk of de- flation very similarly to other types of tail risks such as catastrophic insurance losses. In contrast, inflation tail risk has only a relatively small premium. De- flation risk is also significantly linked to measures of financial tail risk such as swap spreads, corporate credit spreads, and the pricing of super senior tranches. T...
|September 2010||Why Does the Treasury Issue Tips? The Tips-Treasury Bond Puzzle|
with Francis A. Longstaff, Hanno Lustig: w16358
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...
Published: The TIPS—Treasury Bond Puzzle* The Journal of Finance Accepted manuscript online: 30 JAN 2013, Matthias Fleckenstein, Francis A. Longstaff and Hanno Lustig DOI: 10.1111/jofi.12032