Title: Management of indexed government debt: assessing the case for an inflation-indexed bond

Authors: Andrew H. Chen, Elaine T. Chen, R.D. Terrell

Addresses: Edwin L. Cox School of Business, Southern Methodist University, Dallas, TX 75275, USA. ' E. T. Chen Associates, USA. ' National Graduate School of Management, Australian National University, Canberra, Australia

Abstract: Since The US Treasury|s issuance of the inflation- protection securities (TIPS) in January 1997, there has been a great deal of renewed interest in studying various aspects of inflation-indexed bonds. This paper develops an equilibrium capital asset pricing model with uncertain inflation (CAPMUI), of which the Sharpe-Lintner-Mossin and the Roll models are the special cases. Based upon the CAPMUI, we analyse the impact of introducing inflation-indexed bonds on the risk-return relationships in the capital markets. Our analysis indicates that there is no a priori reason to believe that linking the bonds to the price level per se results in a welfare gain in risk-reduction in the capital markets. Our analysis indicates that a non- positive correlation between the return on the market portfolio and the rate of inflation is a sufficient condition for the introduction of indexed bonds to provide welfare gain in risk-reduction in the capital markets.

Keywords: inflation-indexed bonds; TIPS; capital asset pricing models; CAPM; government debt; capital markets.

DOI: 10.1504/IJSTM.2007.013919

International Journal of Services Technology and Management, 2007 Vol.8 No.4/5, pp.261 - 275

Published online: 04 Jun 2007 *

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