The TIPS-Treasury Bond Puzzle





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    • Matthias Fleckenstein is with the UCLA Anderson School. Francis A. Longstaff and Hanno Lustig are with the UCLA Anderson School and the NBER. We are grateful for the comments and suggestions of Andrew Ang, Michael Ashton, Florian Bardong, Derek Barnes, Robert Barro, Jonathan Berkow, Vineer Bhansali, Zvi Bodie, John Brynjolfsson, Mark Buell, Jens Christensen, John Connor, Jacques Drez̀e, Michelle Ezer, Michael Fleming, Shailesh Gupta, David Hsieh, Gang Hu, Jingzhi Huang, Scott Joslin, Narayana Kocherlakota, Jim Lewis, Steven Lippman, Peter Meindl, Robert Merton, Eric Neis, Mike Rierson, Richard Roll, Derek Schaefer, Chester Spatt, Marcus Tom, Luis Viceira, and Ivo Welch, and for the comments and suggestions of seminar participants at AQR Capital Management, Armored Wolf LLC, Blackrock Investment Management, the Federal Reserve Bank of New York, the Federal Reserve Bank of San Francisco, Kepos Capital, Massachusetts Institute of Technology, UCLA, the Spring 2011 National Bureau of Economic Research Asset Pricing Conference, the 6th Annual Central Bank Workshop on the Microstructure of Financial Markets, and the 2011 Western Finance Association Conference. All errors are our responsibility.


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.