This study applies a new arbitrage-free model to decompose yields on Treasury inflation-protected securities (TIPS) into expected real rates, real frictionless term premiums, and liquidity premiums. The analysis points to several key findings.
Abstract
An arbitrage-free model decomposes yields on Treasury Inflation-Protected Securities (TIPS) into expected real rates, real frictionless term premiums, and liquidity premiums. Estimation eschews non-market information, incorporates a novel observable liquidity factor, and addresses factor persistence and sample biases, including real-time estimation. Results include a modest secular decline in equilibrium real rates and a much larger drop in frictionless required excess real returns, on net, from July 1999 to September 2022. Real term premiums appear to be pro-cyclical, which implies that the default risk-free asset is a hedge, and some evidence suggests that TIPS liquidity premiums are counter-cyclical.