Pricing Deflation Risk with US Treasury Yields | Zendy

Jens H. E. Christensen | Zendy; Jose A. Lopez | Zendy; Glenn D. Rudebusch | Zendy

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Pricing Deflation Risk with US Treasury Yields

Author(s) -

Jens H. E. Christensen,

Jose A. Lopez,

Glenn D. Rudebusch

Publication year - 2015

Publication title -

review of finance

Language(s) - English

Resource type - Journals

SCImago Journal Rank - 4.933

H-Index - 61

eISSN - 1875-824X

pISSN - 1572-3097

DOI - 10.1093/rof/rfv029

Subject(s) - deflation , treasury , economics , volatility (finance) , arbitrage , financial crisis , monetary economics , inflation (cosmology) , financial economics , value (mathematics) , basis point , valuation of options , maturity (psychological) , econometrics , monetary policy , keynesian economics , interest rate , mathematics , archaeology , history , psychology , developmental psychology , statistics , physics , theoretical physics

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. 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 5-year maturity was 41 basis points on a par-yield basis. The option value is shown to be closely linked to overall market uncertainty as measured by the VIX, especially during and after the 2008 financial crisis.

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