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The informational content of the embedded deflation option in TIPS
Olesya V. Grishchenko
Joel M. Vanden
Jianing Zhang
In this paper we estimate the value of the embedded option in U.S. Treasury Inflation Protected Securities (TIPS). The option value exhibits significant time variation that is correlated with periods of deflationary expectations. We use our estimated option values to construct an embedded option price index and an embedded option return index. We then use our embedded option indices as independent variables and examine their statistical and economic significance for explaining the future inflation rate. In almost all of our regressions, the embedded option return index is significant even in the presence of traditional inflation variables, such as lagged inflation, the return on gold, the return on crude oil, the VIX index return, and the yield spread between nominal Treasuries and TIPS.We conduct several robustness tests, including alternative weighting schemes, alternative variable specifications, and alternative control variables. We conclude that the embedded option in TIPS contains useful information for future inflation, both in-sample and out-of-sample. Our results should be valuable to anyone who is interested in assessing inflationary expectations.
Olesya V. Grishchenko & Joel M. Vanden & Jianing Zhang, 2013. "The informational content of the embedded deflation option in TIPS," Finance and Economics Discussion Series 2013-24, Board of Governors of the Federal Reserve System (U.S.).
Handle: RePEc:fip:fedgfe:2013-24
File URL: http://www.federalreserve.gov/pubs/feds/2013/201324/201324abs.html
File URL: http://www.federalreserve.gov/pubs/feds/2013/201324/201324pap.pdf
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E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
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