A PRICING ANOMALY IN TREASURY BILL FUTURES

This research applies an entirely new approach to examining the efficiency of futures markets for Treasury bills and avoids many shortcomings of previous studies that rely on comparing yields on spot versus futures market positions. Efficiency is examined by comparing the consistency of yields within the futures market itself since, at one time, the International Monetary Market (IMM) traded futures contracts for both three-month and one-year bills. The results indicate a remarkably large average annual yield differential of 32 basis points when the yields on the one-year contract are compared to the appropriate corresponding strip of three-month contracts. Possible explanations such as low volume, market thinness, transaction costs, strategy interdependence, serial correlation among differences, and daily resettlement (the Cox, Ingersoll, and Ross effect) are unsuccessful in explaining this pricing anomaly.     

SELECTIVE HEDGING OF BANK ASSETS WITH TREASURY BILL FUTURES CONTRACTS

The recent volatility of interest rates, the associated profit pressures imposed on banks, and the surge in the development of new contracts have stimulated a desire to understand and apply financial futures hedging to banking operations. This paper models interest rate futures contracts in a theory of bank behavior to illustrate the hedging of bank loans as well as government securities. The model predicts the hedge will be greater (1) the greater the expected rise in interest rates and (2) the greater the effect of disintermediation on bank deposits. A simulation of the financial futures trading strategy is reported for banks of various asset sizes using data from the Eleventh Federal Reserve District. Depending on bank risk aversion and interest rate expectations, hedging the bank's total interest rate exposure with T-bill futures reduces the variability of unhedged profits by 80 percent.     

TREASURY BILL FUTURES AS A HEDGING TOOL: A RISK-RETURN APPROACH

The primary purpose of this study is to measure the hedging performance of Treasury Bill Futures on a risk-return basis. A theoretical model is presented and hedging effectiveness is tested using T-Bill cash and futures data. Successful hedging depends critically upon the ability to determine the optimal hedge ratio. The results also indicate that the traditional one-to-one hedge outperforms the more sophisticated hedge ratio models; however, even here the risk-return benefits of hedging are minimal.     

A MULTIFACTOR MODEL OF THE QUALITY OPTION IN TREASURY FUTURES CONTRACTS

The values of quality options in Treasury futures contracts are set relative to the prices of all coupon bonds in their respective deliverable sets. As a result, any model used to value the quality option should set its price relative to the set of observed bond prices. This requirement rules out the use of most simple equilibrium models that represent all bond prices in terms of a finite number of state variables. We use the two-factor Heath-Jarrow-Morton model, which permits claims to be priced relative to observable bond prices, to investigate the potential value of the quality option in Treasury bond and note futures. We show that the quality option has significantly more value in a two-factor interest rate economy than in a single-factor economy, and that ignoring it could lead to significant mispricing.     

SLIPPAGE AND THE CHOICE OF MARKET OR LIMIT ORDERS IN FUTURES TRADING

Retail futures traders face uncertainty regarding the price they will obtain when trading. This price "surprise," known as slippage, can be substantial. Using unique data from an introducing brokerage for Chicago Board of Trade (CBOT) wheat, corn, and soybean futures contracts, we quantify time-to-clear and the magnitude of slippage. We then identify factors that affect these trade quality measures. Finally, we analyze individual trader choice between market and limit orders and find that the likelihood of placing limit orders, where regulations protect traders from slippage, is greater when order and market characteristic indicate that adverse slippage is likely.     

FORECASTING THE TREASURY BILL RATE: A TIME-VARYING COEFFICIENT APPROACH

In this paper a time-varying coefficient model is developed using a Kalman filter methodology to test the term structure of interest rates. Since the model is characterized by continuing revision of the estimates when new information arrives, it is capable of capturing the dynamic interest rate behavior, thereby increasing the forecasting accuracy of the future spot rates. With the constant expectations hypothesis rejected, the forecasting accuracy is substantially increased.