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Delivery options and convexity in Treasury bond and note futures

Author

Listed:
  • Grieves, Robin
  • Marcus, Alan J.
  • Woodhams, Adrian

Abstract

Using Treasury bond and note futures to hedge fixed-income portfolios is complicated by the large number of bonds that are eligible to deliver against the contract. Grieves and Marcus [Grieves, R. and A. Marcus. (2005). Delivery options and Treasury bond futures hedge ratios. Journal of Derivatives, 13, 70-76.] show that, in some circumstances, only two bonds--those with the highest and the lowest duration--are relevant for the hedging problem, which makes computation of analytic hedge ratios tractable. We evaluate the empirical efficacy of their two-relevant-bonds model. We compare the maturities of actual cheapest-to-deliver bonds to the prediction of the two-deliverables model and calculate empirical price values of a basis point for Treasury futures contracts to determine whether contract prices display the negative convexity predicted by the model. The model has worked very well for the note contract and very poorly for the bond contract. We show that the difference in model performance is related to the shape of the yield curve.

Suggested Citation

  • Grieves, Robin & Marcus, Alan J. & Woodhams, Adrian, 2010. "Delivery options and convexity in Treasury bond and note futures," Review of Financial Economics, Elsevier, vol. 19(1), pages 1-7, January.
    • Handle: RePEc:eee:revfin:v:19:y:2010:i:1:p:1-7
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    References listed on IDEAS

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    1. Gay, Gerald D. & Manaster, Steven, 1984. "The quality option implicit in futures contracts," Journal of Financial Economics, Elsevier, vol. 13(3), pages 353-370, September.
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    Cited by:

    1. Vahidreza Yousefi & Siamak Haji Yakhchali & Jolanta Tamošaitienė, 2019. "Application of Duration Measure in Quantifying the Sensitivity of Project Returns to Changes in Discount Rates," Administrative Sciences, MDPI, vol. 9(1), pages 1-14, February.
    2. Carcano, Nicola & Dall'O, Hakim, 2011. "Alternative models for hedging yield curve risk: An empirical comparison," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 2991-3000, November.

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    Keywords

    Futures Hedging Convexity;

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