Q&A: Alan Greenspan, the chairman of the Federal Reserve...

...made the following remark concerning the advantages of introducing TIPS: By routinely monitoring the markets for the indexed and unindexed debt instruments, the Federal Reserve could extract the market's evaluation of the consequences of policy operations. Do you agree with his view? What are the potential problems of inferring inflationary expectations from market prices of TIPS?

In principle the yields of TIPS and other nominal Treasury securities and Strips may be used to get some information about how the market perceives the future course of real rates and inflation risks.

There are significant measurement problems. Nominal securities tend to be more liquid than TIPS. This liquidity difference is likely to result in significant differences in the yields of these two classes of securities. The yield difference between nominal securities and TIPS also contains inflation risk premium, which may be varying with time. Hence, we cannot interpret the difference between the yield of nominal and indexed securities as strictly a measure of inflationary expectation.

Category: C++ Quant > Debt

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