TIPS and the VIX: Spillovers from Stock Market Panic to Breakeven Inflation in an Automated, Non-linear Modeling Framework

This paper examines the determinants of the breakeven inflation rate (BEI) on 5 and 10 year US Treasury inflation protected securities (TIPS). The estimation is conducted using a bias-corrected, automated model selection algorithm with indicator saturation and non-linearities. The vast majority of the variation in BEI, over 70%, is attributable not to changes in inflation expectations or liquidity itself but rather a changing preference for liquidity driven by financial market uncertainty. The degree of financial panic is proxied for with the CBOE Volatility Index (VIX). The effect of the VIX on BEI is significant at the 0.1% level, holds even after controlling for inflation expectations and liquidity, and is robust to numerous specifications. Significant effects can also be found under certain specifications for inflation expectations, inflation forecast dispersion, liquidity, and an interaction term between the VIX and liquidity. Further, there is evidence that a rising VIX and declines in liquidity lead to falling BEI at an increasing rate.