siamond wrote:
8. Oh, and longinvest seems to have some qualms about the logic of his own spreadsheet (just when I was starting to like it!). I'll let him elaborate if he feels like it.
There are two parts, to the Synthetic TIPS spreadsheet.
One part for which
the logic works really well. That part is
the TIPS fund simulation part. When we feed it
historical real yields extracted from FRED (along with a linear approximation of missing yields), we get approximate TIPS fund returns that are pretty similar to real-world fund return:
viewtopic.php?p=3159772#p3139060
longinvest wrote:
That's pretty good!
The second part for which
the logic is broken. It's the part which attempts to extract real yields from nominal yields using different approximations of inflation expectations. Logically, if there's any influence of one type of yields on the other, in real life, it should be the other way around: nominal yields being based on real yields and expected inflation. If we had a good approximation of break-even inflation, there wouldn't be any problem. But, it appears that the relation between nominal yields and real yields is not as simple as one would think.
As Stlutz wrote earlier:
viewtopic.php?p=3159772#p3139980
stlutz wrote:One of the reasons for the existence of TIPS is to find out a market expectation of inflation. So, we are trying to solve for something that the experts thought couldn't be determined without creating a new type of security.
All of our attempts, in post 1997 years, at approximating expected inflation failed miserably to give anything near real-world returns. Here's a typical outcome we got,
despite inflation being tame and pretty stable in the last two decades:
viewtopic.php?p=3159772#p3139060
longinvest wrote:
(Don't be fooled by the fact that the curves join back together in the last part of the chart, it's a fluke. Different assumptions lead to different results.)
Actually, in a later post, I extracted linearly approximated real-life inflation expectations across the yield curve, based on FRED nominal and TIPS yields, and I got the following chart where I am unable to detect any stable pattern that could be used to guess the shape of historical inflation expectations across the yield curve:
viewtopic.php?p=3159772#p3139955
longinvest wrote:
Inflation Expectations (zero nominal coupon vs zero real coupon)
As you can see, the expectations are not constant across maturities. ...
In other words, not only we don't have a good estimate of inflation expectations, worse, we would have to guess the shape of these expectations across the yield curve to be able to reconstruct trustworthy TIPS fund returns. It's just too much speculation about what could have happened with TIPS before their introduction into the market, let alone that we're assuming that their existence wouldn't have disturbed the returns of other assets in the market (in other words: zero market impact). That's just too much for me.
siamond wrote:I did copy those updated numbers in the working version of the Simba spreadsheet. And I will retain the 'Synthetic TIPS' name for the data series, as it nicely captures that said data series should really be taken with a giant grain of salt.
Yes, a humongous grain of salt. So huge that I would personally vote
for the removal of synthetic TIPS from the Simba spreadsheet, if there was a vote on it. I think that including the synthetic series does not serve any useful purpose, unless there's a desire to mislead users. People using the spreadsheet expect it to be relatively reliable; I can't say that I have any confidence whatsoever in the adequacy of synthetic TIPS returns to represent what could have happened in pre-TIPS years (and in TIPS years).
For one thing, I don't think that the Kothari/Shanken work modeled a fund with the kind of precision that we have (modeling different rungs). For another, I don't have confidence that they were able to find good inflation expectations that would have worked past 1997, otherwise they would have been proud to include them in their paper. And, lastly, I am sure that they didn't find the pattern of inflation expectation across the yield curve. That would have been a major accomplishment that they would have documented, probably in a paper of its own.
If we could, at least, have validated that the chosen synthetic model works well enough to guess TIPS returns after 1997, we could have some minimal level of confidence in the adequacy of the synthetic returns. Without this, I think that we're just leaving random data in the spreadsheet that will just mislead users.
I won't insist on it. I was just expressing my personal opinion.
Anyway, I'd like to thank Siamond for all his help and comments on the (unfortunatly) failed project of modeling synthetic TIPS.
Siamond is doing all Bogleheads a huge service with all his work on cleaning up Simba's data. Kudos!
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