Relationship between Treasury bills and Eurodollars: Theoretical and Empirical Analyses |
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| Authors: | Cheng-few Lee Keshab Shrestha Robert L Welch |
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| Institution: | (1) Department of Finance, School of Business, Rutgers University, Rutgers, USA;(2) Department of International Business, Dah-Yeh University, Dah-Yeh, Taiwan;(3) Division of Banking and Finance, Nanyang Business School, Nanyang Technological University, 50 Nanyang Avenue, Singapore, Singapore, 639798;(4) Department of Finance, Operations and Information Systems, Faculty of Business, Brock University, Brock, Canada |
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| Abstract: | In this paper, we derive an equilibrium relationship between the yields on Eurodollar and Treasury bills based on equivalent martingale results derived by Harrison and Kreps (1979) and Harrison and Pliska (1981, 1983) as well as the corporate debt pricing model developed by Merton (1974). The derived equilibrium relationship incorporates the models used by Booth and Tse (1995) and Shrestha and Welch (2001) as special cases. The equilibrium relationship indicates that the conditional volatility of the yield on Eurodollars explains the variation in the TED spread.
We empirically test the equilibrium relationship using a GARCH-M model and the concept of fractional cointegration. We use
both the ex ante data implied by the respective futures contracts as well as the ex post spot data with daily, weekly and monthly frequencies. We find empirical support for the Equilibrium relationship.
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| Keywords: | Stationary Fractional cointegration TED spread |
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