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A Note on the Bias of using Futures Rates as a Proxy for the Instantaneous Forward Rate

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  • Thuy-Duong To

    (School of Banking and Finance, University of NSW)

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    Abstract

    The note shows that there is a non-negligible bias in using the futures rates as a proxy for the instantaneous forward rates in the estimation of forward rate models. It is therefore desirable to derive the evolution of observable rates, then use the distributional properties of this evolution to do the estimation. In a general case where these properties are hard to obtained, a filtering technique is required.

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    File URL: http://www.business.uts.edu.au/qfrc/research/research_papers/rp149.pdf
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    Bibliographic Info

    Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 149.

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    Length: 10
    Date of creation: 01 Dec 2004
    Date of revision:
    Handle: RePEc:uts:rpaper:149

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    Keywords: Heath-Jarrow-Morton; forward rate; futures; estimation bias;

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    1. Chapman, David A & Long, John B, Jr & Pearson, Neil D, 1999. "Using Proxies for the Short Rate: When Are Three Months Like an Instant?," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 763-806.
    2. Ram Bhar & Carl Chiarella & Thuy-Duong To, 2004. "Estimating the Volatility Structure of an Arbitrage-Free Interest Rate Model Via the Futures Markets," Finance 0409003, EconWPA.
    3. Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January.
    4. Pearson, Neil D & Sun, Tong-Sheng, 1994. " Exploiting the Conditional Density in Estimating the Term Structure: An Application to the Cox, Ingersoll, and Ross Model," Journal of Finance, American Finance Association, vol. 49(4), pages 1279-1304, September.
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