FYI: We introduce a new arbitrage-free term structure model of nomin
al and real yields that
accounts for liquidity risk in Treasury inflation-protected securitie
s (TIPS). The novel
feature of our model is to identify liquidity risk directly from individual
TIPS prices by
accounting for the tendency that TIPS, like most fixed-income sec
urities, go into buy-
and-hold investors’ portfolios as time passes. We find a sizable and c
ountercyclical TIPS
liquidity premium, which greatly helps our model in matching TIPS prices
. Accounting
for liquidity risk also improves the model’s ability to forecast inflation an
d match inflation
surveys, although none of these series are included in the estimatio
n
Regards,
Ted
http://www.frbsf.org/economic-research/files/wp2017-11.pdf
