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Pricing Treasury Inflation Protected Securities and Related Derivatives using an HJM Model

Published online by Cambridge University Press:  06 April 2009

Robert Jarrow  and
Yildiray Yildirim
Robert Jarrow
Affiliation:
raj 15@cornell.edu, Johnson Graduate School of Management, Cornell University, Ithaca, NY 14853 and Kamakura Corporation
Yildiray Yildirim
Affiliation:
yildiray@syr.edu, School of Management, Syracuse University, Syracuse, NY 13244.
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Abstract

This paper uses an HJM model to price TIPS and related derivative securities. First, using the market prices of TIPS and ordinary U.S. Treasury securities, both the real and nominal zero-coupon bond price curves are obtained using standard coupon bond price stripping procedures. Next, a three-factor arbitrage-free term structure model is fit to the time-series evolutions of the CPI-U and the real and nominal zero-coupon bond price curves. Then, using these estimated term structure parameters, the validity of the HJM model for pricing TIPS is confirmed via its hedging performance. Lastly, the usefulness of the pricing model is illustrated by valuing call options on the inflation index.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 38 , Issue 2 , June 2003 , pp. 337 - 358
Copyright
Copyright © School of Business Administration, University of Washington 2003

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