Assessing the Term Structure of Expected Inflation Using Treasury Inflation-Protected Securities: Near Real-Time Measures for Those Who Need Quick Estimates

By DePrince, Albert E., Jr. | Business Economics, January 2003 | Go to article overview

Assessing the Term Structure of Expected Inflation Using Treasury Inflation-Protected Securities: Near Real-Time Measures for Those Who Need Quick Estimates


DePrince, Albert E., Jr., Business Economics


With the 1997 introduction of Treasury Inflation-Protected Securities, or TIPS, the calculation of market-based inflation expectations became possible. With the passage of time and the issuance of successive securities, it also became possible to estimate the term structure of expected inflation. That is, how do expectations differ over alternative forecast horizons? This paper estimates and assesses such a term structure. The process is fraught with problems stemming from various factors that affect the yields of inflation-protected and conventional securities used to calculate the expected inflation measures. Even so, the study finds that the approach provides at least crude estimates of expected inflation over various forecast horizons, and those estimates represent near real-time measures for those who must make ongoing decisions based on expected inflation. Equally important, this paper provides the reader with an understanding of readily available, market-based forecasts of inflation.

**********

Financial markets provide a wide range of market-based forecasts. Forward interest rates can be derived from spot interest rates, and interest rate futures provide market-based views on expected interest rates and foreign exchange rates. Swap contracts also contain market-based expectations. However, no market-based measures dealt directly with expected inflation until the appearance of Treasury Inflation-Protected Securities (TIPS). Instead, market-wide forecasts could be obtained only from forecast surveys or individual analytic efforts.

This report analyzes the term-structure characteristics of inflation forecasts derived from TIPS from February 1997 to September 2002. It begins with a background on TIPS, followed by a brief description of the concept of the term structure of expected inflation. A model of the yields on the TIPS and conventional Treasury securities is next developed. The process used to generate the term structure of expected inflation from these two classes of securities is reported; and the term structure characteristics are evaluated, and similarities to and differences from survey results are noted. The paper ends with a summary of the key findings.

Background on Treasury Inflation-Protected Securities

On January 29, 1997, the U.S. Treasury issued its first TIPS. These securities were modeled on the government of Canada's Real Return Bonds, and the United States joined eleven current issuers of inflation-protected securities (BOE, 1996), including Australia, Canada, Denmark, Iceland, Ireland, Israel, Mexico, New Zealand, Sweden, Poland, and the United Kingdom.

The U.S. TIPS apply a fixed real coupon rate to a principal (not the coupon rate) that is indexed for inflation and adjusted daily. Specifically, a daily adjustment index is generated through a linear interpolation of adjacent Consumer Price Index values, and this interpolated index is applied each day to the principal. Since there is a two-month lag between the current month's value of the inflation-adjusted principal and the latest CPI used in the indexation, one could argue that indexation is a bit incomplete.

The semi-annual coupon payment is the product of a stated real coupon rate and the inflation-accreted principal. As a result, the nominal coupon payments will rise month by month if the accreted principal rises, but there is no change in the real coupon rate. The accreted principal is not paid with the coupons, but accrues and is paid at maturity. The coupon payments and principal accrued between coupon dates are considered currently taxable income, even though the accrued principal is not paid until maturity. By October 31, 2002, the outstanding inflation-protected notes and bonds totaled $146.4 billion, including $11.0 billion of accrued principal.

The Treasury's auction cycle for TIPS has evolved over the years. At this time, the benchmark inflation-protected security is the ten-year note. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Assessing the Term Structure of Expected Inflation Using Treasury Inflation-Protected Securities: Near Real-Time Measures for Those Who Need Quick Estimates
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.