A1283
Title: Got the X-Factor? A simple estimate for TIPS liquidity risk
Authors: Marcel Stechert - Aarhus University (Denmark) [presenting]
Abstract: The market for US inflation-protected securities (TIPS) grew rapidly over the last decades but remains less liquid compared to the nominal market. A simple but convenient estimate for TIPS-specific liquidity risk at any maturity is proposed. If interest is only in the liquidity risk component, this approach works within a fraction of seconds, compared to other approaches which estimate the whole state-space. The proposed approach only requires a joint panel of zero-coupon nominal and TIPS treasury yields and, thus, provides yield-consistent and TIPS-market specific liquidity risk estimates. This comes with two main advantages: (i) avoids empirical liquidity risk proxies and (ii) no estimation of fully-fledge term structure model. Instead, static principal components and linear projections are sufficient to estimate a generalized, but rotated, linear factor model for the joint set of yields. This is easy, fast and robust (i.e. minimum identification assumptions). The resulting liquidity factor and implied liquidity risk premium estimates show economically plausible dynamics and, seemingly, only a small 'loss' compared to existing, more sophisticated methods. Additionally, monte-carlo simulations validate that the PCA estimate recovers the true liquidity state from a state-of-the-art term structure model with TIPS specific liquidity risk. Finally, bond risk predictability exercises empirically verify show that TIPS liquidity is a priced risk factor in the US TIPS market.
