Financial Innovation and the Role of Derivative Securities: An Empirical Analysis of the Treasury STRIPS Program


  • Mark Grinblatt,

  • Francis A. Longstaff

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    • The Anderson School at UCLA. We are grateful for the comments of Kaushik Amin, Gregory Duffee, Mark Fisher, Hedi Kallal, Avi Kamara, Janet Showers, and seminar participants at the University of Arizona, Arizona State University, the Federal Reserve of New York, the University of Illinois at Urbana/Champaign, Kansas State University, New York University, the Quantitative Investment Association, Rutgers University, Vanderbilt University, the 1996 American Finance Association meetings, and the 1996 Western Finance Association meetings. We thank James Brandon, Ravi Jain, Toby Moskowitz, Robert Michaud, Sunny Nguyen, and Michelle Pham for capable research assistance. We are especially grateful for the suggestions of René Stulz and two anonymous referees. All errors are our responsibility.


The role that financial innovation plays in financial markets is very controversial. To provide insight into this role, we examine how market participants use the highly successful Treasury STRIPS program. We find that investors use the option to create Treasury-derivative STRIPS primarily to make markets more complete and take advantage of tax and accounting asymmetries. Although liquidity-related factors help explain differences in the prices of Treasury bonds and STRIPS, we find little evidence that the option to strip and reconstitute securities is used for speculative or arbitrage-related purposes.