© 2017 The Department of Economics, University of Oxford and John Wiley & Sons Ltd.
OXFORD BULLETIN OF ECONOMICS AND STATISTICS, 80, 2 (2018) 0305–9049
TIPS and the VIX: Spillovers from Financial Panic
to Breakeven Inﬂation in an Automated, Nonlinear
Josh R. Stillwagon
†Economics Division, Babson College, Institute for New Economic Thinking (INET)
Program on Imperfect Knowledge Economics (IKE), Westgate Hall 313, 231 Forest Street,
Babson Park, MA 02457, USA (e-mail: firstname.lastname@example.org)
This paper examines the determinants of the breakeven inﬂation rate (BEI) on U.S. Treasury
Inﬂation Protected Securities. After controlling for several measures of liquidity, inﬂation
expectations and inﬂation uncertainty; ﬁnancial fear itself (proxied with theVolatility Index
or VIX) remains a primary inﬂuence on BEI. To delve into the mechanism underlying this
association, the VIX is decomposed, using intraday data, into conditional variance and the
variance premium capturing risk aversion. Aside from the 2008 crisis, most of the effect
emanated from the variance premium. Following the crisis, indicators of bank insolvency
risk gain prominence as well. Lastly, an automated nonlinear model ﬁnds convex effects
of variance, and diminishing returns to insolvency risk and liquidity.
I. TIPS breakeven inﬂation and ﬂights to liquidity
Since the inception of inﬂation indexed bonds, ﬁrst in the UK in 1981 and then in the US in
1997, these guaranteed real interest rates have intrigued both researchers and policymakers
for their informational content.
The spread between traditional Treasury rates and those
on Treasury Inﬂation Protected Securities (TIPS), referred to as the breakeven inﬂation
rate (BEI), has often been invoked as a real time, market-based measure of inﬂation expec-
tations. This follows from the supposition that arbitrage should equalize the two expected
real returns. It has long been recognized however that inﬂation risk premia are important
drivers of nominal yields and can help to account for deviations from the expectations
JEL Classiﬁcation numbers: E43, G12, G01, C22, C52.
*I thank INET and Trinity College for ﬁnancial support of this research, and Marie Hoerova and Steve Furnagiev
for data. I also thank a number of people for very helpful comments including two anonymous referees, Anindya
Banerjee, Geert Bekaert, Jurgen Doornik, Neil Ericsson, Deniz Erdemlioglu, Roman Frydman, Michael D. Goldberg,
David Hendry, Chris Hoag, Sebastian Laurent, Bent Nielsen, Frank Strobel, Giovanni Urga, and other participants
of the 16th Oxmetrics Conference at Aix-Marseille University and seminars at Trinity College, the University of
New Hampshire, Sacred Heart University, Appalachian State University, and Babson College. Any errors of course
remain solely those of the author.
Barr and Campbell (1997) provides an early study. D’Amico, Kim and Wei (2010) note examples of references
to TIPS in FOMC meetings and Fed speeches.