Working Paper
Pricing deflation risk with U.S. Treasury yields
Abstract: We use an arbitrage-free term structure model with spanned stochastic volatility to determine the value of the deflation protection option embedded in Treasury inflation-protected securities (TIPS). The model accurately prices the deflation protection option prior to the financial crisis when its value was near zero; at the peak of the crisis in late 2008 when deflationary concerns spiked sharply; and in the post-crisis period. During 2009, the average value of this option at the five-year maturity was 41 basis points on a par-yield basis.
Keywords: Deflation (Finance); Inflation-indexed bonds - United States;
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Bibliographic Information
Provider: Federal Reserve Bank of San Francisco
Part of Series: Working Paper Series
Publication Date: 2012
Number: 2012-07