Futures Prices on Yields, Forward Prices, and Implied Forward Prices from Term Structure

When futures contracts are settled with respect to underlying asset prices, received theory suggests that the differences between futures prices and implied forward prices (from the term structure) are strictly due to marking to market, ceteris paribus. Empirical evidence appears to indicate that such differences are small for contracts with short maturities. What happens when the futures contract settles to yields implied by future prices of underlying assets? The Eurodollar futures contract, which is the most actively traded futures contract in the United States, settles to yield as opposed to prices. This unique settlement feature is shown to imply that the implied forward prices from the LIBOR term structure should differ from the futures prices even in the absence of marking to market. Differences due to marking to market effect are small: they are shown to vary between 2 to 45 basis points (less than one-half percent of futures prices). On the other hand, differences between implied forward prices and futures prices are shown to be relatively large.