An empirical analysis of the delivery option, marking to market, and the pricing of treasury bond futures

✍ Scribed by Simon Benninga; Michael Smirlock

• Publisher: John Wiley and Sons
• Year: 1985
• Tongue: English
• Weight: 788 KB
• Volume: 5
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.3990050307

✦ Synopsis

ike many other futures contracts, the Treasury Bond (T-Bond) futures contract L allows the holder of a short position to satisfy the contract by delivering one of the variety of T-Bonds on one of a number of delivery dates. Accordingly, the traditional approach to pricing such contracts has concentrated almost exclusively on the concept of "cheapest to deliver," which treats the futures contract as if i t were a forward contract and asserts that the price of the futures contract will be determined by the minimal cost of carrying any deliverable bond to the maturity of the contract. Several recent studies have extended the pricing analysis in two ways that incorporate the distinctions between forward and futures contracts. First, Cox, Ingersoll, and Ross (CIR) (1981), Jarrow and Oldfield (1981) and Richard and Sundarsen (1981) have stressed that marking to market drives a wedge between the futures price of an asset and the forward price of the same asset.' Second, Garbade and Silber (1981) and Gay and Manaster (1983) have presented alternative approaches that explicitly incorporate the deliverer's right to switch from one quality of deliverable goods to another at the time of maturity. If at the time the contract is purchased, knowledge of which of the deliverable assets will be cheapest to deliver is uncertain, then the "quality variation" option will have value.

Any attempt to explore the pricing of T-Bond futures must take account of both *The authors wish to thank Jay Mervrs for his exrellent reseawh assistance. 'The theoretical literature cited in the text indicates thal when thew is 110 tielively option, fntures at111 forward prices will diverge by a term that represents the cost of marking to market.