A model-independent maximum range for the liquidity correction of TIPS yields

Abstract

We derive a model-independent maximum range for the admissible liquidity risk premium in real Treasury bonds—also known as Treasury Inflation Protected Securities (TIPS). The range is constructed using additional information in the inflation swap market and a set of simple theoretical assumptions. As an application, we construct a lower bound to estimates of the inflation risk premium the Treasury receives from TIPS by deducting their maximum liquidity premium. This conservative measure of the benefit to the Treasury of issuing TIPS is positive on average at the ten-year maturity for our sample period.Inflation (Finance) ; Inflation-indexed bonds