The Puzzle of Treasury Option Returns

49 Pages Posted: 28 Jun 2019 Last revised: 1 Jul 2022

See all articles by Gurdip Bakshi

Gurdip Bakshi

Fox School of Business; Temple University - Fox School of Business and Management

John Crosby

University of Maryland - Robert H. Smith School of Business

Xiaohui Gao

Fox School of Business, Temple University

Date Written: August 6, 2019

Abstract

Puzzling to many interest-rate option models, average excess returns of out-of-the-money puts and calls on bond futures are both negative, unconditionally and conditional on economic states. We explore sources of negative average option excess returns and empirically reject hypotheses linked to the predominance of spanned risks. Resolving the puzzle, we develop economically motivated restrictions in the context of a theory in which the pricing kernel is a general diffusion process with spanned and unspanned components. Our reconciliation is a framework that introduces market incompleteness and priced unspanned volatility risks, allowing for time-varying downside and upside futures risk premiums.

Keywords: Options on futures of Treasury bonds, interest-rate models, option risk premiums, unspanned risks in the pricing kernel

JEL Classification: G00, G12, G13, G15

Suggested Citation

Bakshi, Gurdip S. and Bakshi, Gurdip S. and Crosby, John and Gao, Xiaohui, The Puzzle of Treasury Option Returns (August 6, 2019). Available at SSRN: https://ssrn.com/abstract=3410542 or http://dx.doi.org/10.2139/ssrn.3410542

Gurdip S. Bakshi

Fox School of Business ( email )

Department of Finance
Philadelphia, PA 19022
United States
215-204-6117 (Phone)
tuk40718@temple.edu (Fax)

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Temple University - Fox School of Business and Management ( email )

Philadelphia, PA 19122
United States

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

John Crosby (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
+447979901892 (Phone)

HOME PAGE: http://www.john-crosby.co.uk/

Xiaohui Gao

Fox School of Business, Temple University ( email )

Alter Hall 421
Philadelphia, PA 19122
United States

HOME PAGE: http://https://sites.google.com/site/xiaohuigaobakshi/

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