Tips from TIPS: The Informational Content of Treasury Inflation-Protected Security Prices

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Abstract
We examine the informational content of TIPS yields from the viewpoint of a general 3-factor no-arbitrage term structure model of in∞ation and interest rates. Our empirical results indicate that TIPS yields contained a \liquidity premium" that was until recently quite large (» 1%). Key features of this premium are di-cult to account for within a simple rational framework, suggesting that TIPS may not have been priced e-ciently in its early years. Nonetheless, the weekly change in TIPS breakeven rate (difierence between nominal and TIPS yields) is similar to that of the in∞ation expectation implied by the model, lending support to the view that the TIPS breakeven rate is a useful proxy for in∞ation expectations.