Delivery Options and Convexity in Treasury Bond and Note Futures

22 Pages Posted: 14 Jul 2008

See all articles by Robin Grieves

Robin Grieves

Rollins College - Crummer Graduate School of Business

Alan J. Marcus

Boston College - Department of Finance

Adrian Woodhams

Goldman Sachs JBWere

Date Written: July 13, 2008

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 (2005) show that in some circumstances, only two bonds - those with the highest and the lowest durations - are relevant for the hedging problem, which makes computation of analytic hedge ratios tractable. We evaluate the empirical efficacy of their two-relevant-bond model. We compare the maturities of actual cheapest-to-deliver bonds to the prediction of the two-deliverable 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 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.

Keywords: Delivery options, convexity, Treasury futures, hedging, PVBP

JEL Classification: G10, G13

Suggested Citation

Grieves, Robin and Marcus, Alan J. and Woodhams, Adrian, Delivery Options and Convexity in Treasury Bond and Note Futures (July 13, 2008). Available at SSRN: https://ssrn.com/abstract=1159562 or http://dx.doi.org/10.2139/ssrn.1159562

Robin Grieves

Rollins College - Crummer Graduate School of Business ( email )

Winter Park, FL 32789
United States
1-407-646-2438 (Phone)

Alan J. Marcus (Contact Author)

Boston College - Department of Finance ( email )

Fulton Hall
Chestnut Hill, MA 02467
United States
617-552-2767 (Phone)
617-552-0431 (Fax)

Adrian Woodhams

Goldman Sachs JBWere ( email )

Level 38 Vero Centre
48 Shortland Street
Auckland, 1010
New Zealand

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