Strategies · Library · Weather, energy, inflation
§14.2Pairs and relative value
TIPS-Treasury arbitrage
Sell a Treasury bond and buy a replicating package: an inflation-protected bond, inflation swaps that turn its indexed coupons into fixed ones, and small zero-coupon bond positions to match the rest. The package replicates the Treasury's payments for less than the Treasury costs, leaving an upfront gain.
- Asset class
- Weather, energy, inflation
- Held for
- Years
- Data
- Needs data ARCANE lacks
- Symphony
- Cannot be built as a symphony
The rule
- Signal
- Upfront cash difference between the Treasury and its replicating package.
- Entry and exit
- Open all legs at once; cash flows then net to zero until maturity.
- Sizing
- Swap and zero-coupon sizes set to match each coupon and the principal.
How it fails
- Funding and balance-sheet costs
- Swap counterparty risk
- Tiny edge relative to size
Data it needs
- Treasury prices
- TIPS prices
- inflation swap rates
- zero-coupon bond prices
ARCANE has no individual bond prices or swap quotes.
How ARCANE uses it
Not usable.
Needs individual bonds, swaps and shorting.
Filed under the pairs and statistical arbitrage card
Find two securities whose prices moved together for a year. When the gap between them opens past two standard deviations, buy the laggard and sell the leader.
A paper plan from this card holds 5 to 126 days, stops at 1.5× the expected move and uses at most 50% of your risk budget. The card
Source: Kakushadze and Serur (2018), 151 Trading Strategies, §14.2, p. 106 of the SSRN version. Described in our words. Pairs and relative value is ARCANE’s filing, not the book’s.