Economic Policy Review Executive Summary

The Microstructure of the TIPS Market

Recapping a forthcoming article from the Economic Policy Review
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19 pages / 552 kb

Authors: Michael J. Fleming and Neel Krishnan

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Index of executive summaries
  • The expected benefits from the 1997 introduction of Treasury inflation-protected securities, or TIPS, have not been fully realized, mainly because TIPS are less liquid than nominal Treasury securities.

  • Because of this relative lack of liquidity, some view TIPS yields as carrying a liquidity premium compared with nominal Treasuries, a factor that offsets the advantages of TIPS’ absence of inflation risk.

  • In 2011, there is still little quantitative evidence on TIPS liquidity. While Federal Reserve data show that TIPS trading activity is much lower than activity in nominal securities, the data are aggregated over the week and across all TIPS and cover only trading volume. So they provide no information on activity in particular TIPS, activity over the day or week, or other measures of liquidity, such as bid-ask spreads.

  • Fleming and Krishnan, using more granular “tick” data from the interdealer market, provide new evidence on the liquidity of TIPS and how it differs from that of nominal securities.

  • The authors identify several features of the TIPS market also present in the nominal securities market, but some unique features as well.

  • In both markets, a significant difference in trading activity is found between the most recently issued ( “on-the-run”) and previously issued ( “off-the-run”) securities, as trading drops sharply when securities go off the run. In the TIPS market, there is little difference in bid-ask spreads or quoted depth between securities, but large variation in the incidence of posted quotes.

  • Trading activity and the incidence of posted quotes, according to the study, may therefore be better cross-sectional measures of TIPS liquidity than bid-ask spreads or quoted depth.

  • Intraday trading patterns are shown to be broadly similar in both markets, but TIPS activity peaks somewhat later—likely reflecting differences in the use and ownership of the securities.

  • The effects of public announcements (the CPI release, employment report, FOMC post-meeting announcement, and TIPS auction results) differ between markets, with TIPS auction results and CPI releases eliciting especially strong increases in trading activity, likely indicating these announcements’ particular importance to TIPS valuation.


About the Authors

Michael J. Fleming is a vice president at the Federal Reserve Bank of New York; Neel Krishnan is a former research associate at the Bank.

Disclaimer

The views expressed in this summary are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System.