Pricing Treasury Inflation Protected Securities and Related Derivatives using an HJM Model

1 June 2003

journal article
Published by JSTOR in Journal of Financial and Quantitative Analysis

Vol. 38 (2) , 337
https://doi.org/10.2307/4126754

Abstract

This paper uses an HJM model to price TIPS and related derivative securities. First, using the market prices of TIPS and ordinary U.S. Treasury securities, both the real and nominal zero-coupon bond price curves are obtained using standard coupon bond price stripping procedures. Next, a three-factor arbitrage-free term structure model is fit to the time-series evolutions of the CPI-U and the real and nominal zero-coupon bond price curves. Then, using these estimated term structure parameters, the validity of the HJM model for pricing TIPS is confirmed via its hedging performance. Lastly, the usefulness of the pricing model is illustrated by valuing call options on the inflation index.

Keywords

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