A Note on the Stability of Lognormal Interest Rate Models and the Pricing of Eurodollar Futures
The lognormal distribution assumption for the term structure of interest is the most natural way to exclude negative spot and forward rates. However, imposing this assumption on the continuously compounded interest rate has a serious drawback: rates explode and expected rollover returns are infinite even if the rollover period is arbitrarily short. As a consequence, such models cannot price one of the most widely used hedging instruments on the Euromoney market, namely the Eurodollar futures contract. Copyright Blackwell Publishers Inc. 1997.
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Volume (Year): 7 (1997)
Issue (Month): 2 ()
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References listed on IDEAS
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- K. Sandmann & Sondermann, D., 1993. "A Term Structure Model and the Pricing of Interest Rate Derivative," Discussion Paper Serie B 180, University of Bonn, Germany.
- Dothan, L. Uri, 1978. "On the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 6(1), pages 59-69, March.
- Cox, John C. & Ingersoll, Jonathan Jr. & Ross, Stephen A., 1981. "The relation between forward prices and futures prices," Journal of Financial Economics, Elsevier, vol. 9(4), pages 321-346, December.
- 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.
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