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A hedging deficiency in eurodollar futures

✍ Scribed by Don M. Chance

Publisher
John Wiley and Sons
Year
2005
Tongue
English
Weight
145 KB
Volume
26
Category
Article
ISSN
0270-7314

No coin nor oath required. For personal study only.

✦ Synopsis

Abstract

The eurodollar futures contract of the Chicago Mercantile Exchange is arguably the most successful of all futures contracts. The contract is structured such that its price does not converge to the price of the underlying eurodollar time deposit. Ignoring the daily settlement, one typically assumes that a eurodollar futures contract perfectly hedges an anticipated loan pegged to LIBOR, provided the loan rate is set at the eurodollar expiration. This article demonstrates that this hedge is not perfect, leaving a risk empirically estimated at four basis points, a seemingly small amount but considerably larger than the bid–ask spread on the futures. Β© 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:189–207, 2006

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I am thankful to David Bates and Doug Foster. Comments from an anonymous referee and from Mark Powers are gratefully acknowledged.

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