The TIPS-Treasury Bond Puzzle

The TIPS-Treasury Bond Puzzle

By
Hanno Lustig, Matthias Fleckenstein, Francis A. Longstaff
The Journal of Finance. September
12, 2014, Vol. 69, Issue 5, Pages 2151-2197

We show that the price of a Treasury bond and an inflation-swapped Treasury Inflation-Protected Securities (TIPS) issue exactly replicating the cash flows of the Treasury bond can differ by more than $20 per $100 notional. Treasury bonds are almost always overvalued relative to TIPS. Total TIPS-Treasury mispricing has exceeded $56 billion, representing nearly 8% of the total amount of TIPS outstanding. We find direct evidence that the mispricing narrows as additional capital flows into the markets. This provides strong support for the slow-moving-capital explanation of arbitrage persistence.