Information Content of Inflation-Indexed Bond Prices: Evaluation of U.S. Treasury Inflation-Protection Securities

In January 1997, the U.S. Treasury started issuing Treasury Inflation-Protection Securities (TIPS; hereafter TIPS and indexed bonds interchangeably) and, as of September 2002, a total of 10 issues were being traded on the market, while one issue had already matured. The purpose of this paper is to attempt an evaluation of indexed bonds based on the record of five and a half years of market trading in TIPS, and to present the results as a reference for the issue of similar securities by the Japanese government in the future. The results of this paper are as follows. (1) Real interest rates are relatively stable and remain near the 4 percent mark. The 30-year bond is even more stable. (2) The expected inflation rate is more closely linked to the realized consumer price index (CPI) than to the real yield. However, the expected inflation rate is far more stable and its fluctuations smaller. In particular, the 30-year bond is steady, near the 2 percent mark. (3) While the economic information derived from the 10-year bond is strongly influenced by short-term economic fluctuations, the economic information derived from the 30-year bond is generally unresponsive to short-term economic fluctuations. (4) Examination of the derived information using econometric methods indicates that useful economic information was obtained from the following indexed bonds in the secondary markets: Series Three and Four 10-year bonds. Hence, while a total of 11 indexed bonds have been issued, very few of them have proven to be truly useful. These useful bonds turn out to have fair initial conditions, are continuously arbitraged with the nominal bonds, and trade actively in the secondary markets.