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Why does the Treasury issue TIPS? : the TIPS-Treasury bond puzzle

Author: Matthias Fleckenstein; Francis A Longstaff; Hanno Lustig; National Bureau of Economic Research.
Publisher: Cambridge, Mass. : National Bureau of Economic Research, ©2010.
Series: Working paper series (National Bureau of Economic Research), no. 16358.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
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  Read more...
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Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Matthias Fleckenstein; Francis A Longstaff; Hanno Lustig; National Bureau of Economic Research.
OCLC Number: 663974958
Notes: "September 2010."
Title from http://www.nber.org/papers/16358 viewed Sept. 14, 2010.
Description: 1 online resource (35, [13] pages) : illustrations.
Series Title: Working paper series (National Bureau of Economic Research), no. 16358.
Responsibility: Matthias Fleckenstein, Francis A. Longstaff, Hanno Lustig.

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.

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