The Relative Pricing of Eurodollar Futures and Forward Contracts
Posted: 16 Sep 1999
Date Written: March 1994
Recent research reports significant differences between Eurodollar futures and forward interest rates. In this paper, we document that the futures-forward yield difference was economically and statistically significant only in the early years of the Eurodollar futures contract. The difference has steadily diminished and in recent years has been negligible of nonexistent. The primary explanation in the literature for the observed differences between the futures and forward Eurodollar yields has been the mark-to- market feature of the futures contracts. We derive closed form solutions for the futures-forward yield difference under two popular term structure models and show that the theoretical futures-forward yield difference is indeed small. We also find that liquidity differences and default risk premia cannot explain the large differences observed in the early part of the sample period. Furthermore, we find that there was a delay in the flow of information between the spot and the futures markets during the early years of the futures contract, but we find no evidence of such a delay in the later years. Our results suggest that the differences between the futures and forward rates observed in the early part of the sample period is likely to be attributable to the mispricing of futures contracts relative to the forward rates and that the mispricing was eliminated over time.
JEL Classification: 313
Suggested Citation: Suggested Citation