Working Paper: NBER ID: w16358
Authors: 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.
Keywords: TIPS; Treasury Bonds; Arbitrage; Mispricing; Government Finance
JEL Codes: E6; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| price of Treasury bonds (E43) | price of inflation-swapped TIPS (E31) |
| supply factors (Treasury debt issuance) (H63) | size of the arbitrage opportunities between TIPS and Treasury bonds (E43) |
| repo failures (C59) | increased mispricing (G19) |
| issuing TIPS (G12) | loss of fiscal options (E62) |