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Are Negative Option Prices Possible? The Callable U.S. Treasury-Bond Puzzle

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  • Longstaff, Francis A

Abstract

Market prices for callable Treasury bonds often imply negative values for the implicit call option. The author considers a variety of possible explanations for these negative values including the Treasury's track record in calling bonds optimally, tax-related effects, tax-timing options, and bond liquidity. None of these factors accounts for the negative values. Although the costs of short selling may explain why these apparent arbitrage opportunities persist over time, why these implicit call values become negative in the first place remains a puzzle. Copyright 1992 by University of Chicago Press.

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Bibliographic Info

Article provided by University of Chicago Press in its journal Journal of Business.

Volume (Year): 65 (1992)
Issue (Month): 4 (October)
Pages: 571-92

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Handle: RePEc:ucp:jnlbus:v:65:y:1992:i:4:p:571-92

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Web page: http://www.journals.uchicago.edu/JB/

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Cited by:
  1. Gagnon, Louis & Andrew Karolyi, G., 2010. "Multi-market trading and arbitrage," Journal of Financial Economics, Elsevier, vol. 97(1), pages 53-80, July.
  2. Longstaff, Francis A., 2001. "The Flight-to-Liquidity Premium in U.S. Treasury Bond Prices," University of California at Los Angeles, Anderson Graduate School of Management qt7dc0t95b, Anderson Graduate School of Management, UCLA.
  3. Jason Seligman, 2012. "Support of State and Local Finance under Persistent Federal Deficits," International Advances in Economic Research, Springer, vol. 18(4), pages 383-395, November.
  4. Matthias Fleckenstein & Francis A. Longstaff & Hanno Lustig, 2010. "Why Does the Treasury Issue Tips? The Tips–Treasury Bond Puzzle," NBER Working Papers 16358, National Bureau of Economic Research, Inc.
  5. Xie, Yan Alice & Liu, Sheen & Wu, Chunchi & Anderson, Bing, 2009. "The effects of default and call risk on bond duration," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1700-1708, September.
  6. Jordan, Bradford D. & Jordan, Susan D. & Jorgensen, Randy D., 1995. "A reexamination of option values implicit in callable Treasury bonds," Journal of Financial Economics, Elsevier, vol. 38(2), pages 141-162, June.
  7. Jarrow, Robert & Li, Haitao & Liu, Sheen & Wu, Chunchi, 2010. "Reduced-form valuation of callable corporate bonds: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 95(2), pages 227-248, February.
  8. Kahl, Matthias & Liu, Jun & Longstaff, Francis A., 2003. "Paper millionaires: how valuable is stock to a stockholder who is restricted from selling it?," Journal of Financial Economics, Elsevier, vol. 67(3), pages 385-410, March.
  9. Flandreau, Marc & Oosterlinck, Kim, 2012. "Was the emergence of the international gold standard expected? Evidence from Indian Government securities," Journal of Monetary Economics, Elsevier, vol. 59(7), pages 649-669.
  10. Jordan, Bradford D. & Kuipers, David R., 1997. "Negative option values are possible: The impact of Treasury bond futures on the cash U.S. Treasury market," Journal of Financial Economics, Elsevier, vol. 46(1), pages 67-102, October.
  11. King, Tao-Hsien Dolly, 2007. "Are embedded calls valuable? Evidence from agency bonds," Journal of Banking & Finance, Elsevier, vol. 31(1), pages 57-79, January.
  12. Kahl, Matthias & Liu, Jun & Longstaff, Francis A, 2001. "Paper Millionaires: How Valuable is Stock to a Stockholder Who is Restricted from Selling it?," University of California at Los Angeles, Anderson Graduate School of Management qt8b3853z9, Anderson Graduate School of Management, UCLA.
  13. Ioffe, Ioulia D., 2002. "Arbitrage bounds in markets with noisy prices and the puzzle of negative option prices implicit in bonds," Journal of Banking & Finance, Elsevier, vol. 26(6), pages 1199-1228, June.

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