NEW YORK—Despite a low level of activity and its over-the-counter nature, the U.S. inflation swap market is reasonably liquid and transparent. That is, transaction prices for this market are quite close to widely available end-of-day quoted prices, and realized bid-ask spreads are modest.
In a new report from the Federal Reserve Bank of New York, authors Michael J. Fleming and John R. Sporn use transaction data from derivatives dealers to shed light on the rapidly growing market for over-the-counter inflation swaps. Specifically, they analyze zero-coupon inflation swap trades involving major derivatives dealers for a three-month period in 2010. Their research reveals that the market was fairly inactive and exhibited concentrations of activity in certain tenors and trade sizes and among certain market participants. Nevertheless, the authors find that the market appears relatively liquid and transparent, with trade prices typically near publicly available midquotes and bid-ask spreads reasonably narrow. “This likely reflects the fact that the market is part of a larger market for transferring inflation risk that includes TIPS and nominal Treasury securities,” note the authors.
The report, “Trading Activity and Price Transparency in the Inflation Swap Market,” also provides a description of how inflation swaps work and the market in which they trade, as well as details about the data used in the analysis and the study’s empirical results.
Michael J. Fleming is a vice president in the New York Fed’s Research and Statistics Group and John R. Sporn is a senior analyst in the Markets Group.