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The Quality Delivery Option in Treasury Bond Futures Contracts

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  • Hemler, Michael L

Abstract

This paper uses three methods to estimate quality option values for Chicago Board of Trade Treasury bond futures contracts. It presents evidence regarding payoffs from exercising this option at delivery, estimates from a T-bond futures pricing model that incorporates this option, and estimates obtained from an exchange option pricing formula. The results indicate that this option is worth considerably less than reported by A. Kane and A. Marcus (1986). For example, payoffs obtained by switching from the bond cheapest to deliver three months prior to delivery to the one cheapest at time of delivery average less than 0.30 percentage points of par. Copyright 1990 by American Finance Association.

Suggested Citation

  • Hemler, Michael L, 1990. "The Quality Delivery Option in Treasury Bond Futures Contracts," Journal of Finance, American Finance Association, vol. 45(5), pages 1565-1586, December.
    • Handle: RePEc:bla:jfinan:v:45:y:1990:i:5:p:1565-86
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    Cited by:

    1. Adam-Müller, Axel F. A. & Wong, Kit Pong, 2002. "The impact of delivery risk on optimal production and futures hedging," CoFE Discussion Papers 02/08, University of Konstanz, Center of Finance and Econometrics (CoFE).
    2. Brad A. Badertscher & Dan Givoly & Sharon P. Katz & Hanna Lee, 2019. "Private Ownership and the Cost of Public Debt: Evidence from the Bond Market," Management Science, INFORMS, vol. 65(1), pages 301-326, January.
    3. Bing-Huei Lin & Ren-Raw Chen & Jian-Hsin Chou, 1999. "Pricing and quality option in Japanese government bond futures," Applied Financial Economics, Taylor & Francis Journals, vol. 9(1), pages 51-65.
    4. Michèle Breton & Ramzi Ben‐Abdallah, 2018. "Time is money: An empirical investigation of delivery behavior in the U.S. T‐Bond futures market," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 38(1), pages 22-37, January.
    5. Cremers, Martijn & Fleckenstein, Matthias & Gandhi, Priyank, 2021. "Treasury yield implied volatility and real activity," Journal of Financial Economics, Elsevier, vol. 140(2), pages 412-435.
    6. Lien, Donald & Tse, Yiu Kuen, 2006. "A survey on physical delivery versus cash settlement in futures contracts," International Review of Economics & Finance, Elsevier, vol. 15(1), pages 15-29.
    7. Hess, Dieter E., 2000. "Surprises in scheduled releases: why do they move the bond market?," ZEW Discussion Papers 00-61, ZEW - Leibniz Centre for European Economic Research.
    8. Nicola Fusari & Wei Li & Haoyang Liu & Zhaogang Song, 2022. "Asset Pricing with Cohort‐Based Trading in MBS Markets," Journal of Finance, American Finance Association, vol. 77(6), pages 3249-3287, December.
    9. Nicola Fusari & Wei Li & Haoyang Liu & Zhaogang Song, 2020. "Asset Pricing with Cohort-Based Trading in MBS Markets," Staff Reports 931, Federal Reserve Bank of New York.
    10. David C. Ling, 1993. "Mortgage‐Backed Futures and Options," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 21(1), pages 47-67, March.
    11. Ren-Raw Chen & Shih-Kuo Yeh, 2012. "Analytical bounds for Treasury bond futures prices," Review of Quantitative Finance and Accounting, Springer, vol. 39(2), pages 209-239, August.
    12. Merrick, John Jr & Naik, Narayan Y. & Yadav, Pradeep K., 2005. "Strategic trading behavior and price distortion in a manipulated market: anatomy of a squeeze," Journal of Financial Economics, Elsevier, vol. 77(1), pages 171-218, July.
    13. Dan Givoly & Carla Hayn & Sharon Katz, 2017. "The changing relevance of accounting information to debt holders over time," Review of Accounting Studies, Springer, vol. 22(1), pages 64-108, March.
    14. Balbás, Alejandro & Reichardt, Susana, 2006. "On the future contract quality option: a new look," DEE - Working Papers. Business Economics. WB wb063711, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    15. João Pedro Vidal Nunes & Luís Alberto Ferreira De Oliveira, 2007. "Multifactor and analytical valuation of treasury bond futures with an embedded quality option," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 27(3), pages 275-303, March.
    16. Alejandro Balbas & Susana Reichardt, 2010. "On the future contract quality option: a new look," Applied Financial Economics, Taylor & Francis Journals, vol. 20(15), pages 1217-1229.

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