An Investigation of Cheapest to Deliver on Treasury Bond Futures Contracts
Posted: 21 Jun 1998
Date Written: May 1996
An extensive cheapest-to-deliver (CTD) literature has become mired in the misconception that the CTD is characterizable in terms of duration. We show that exceptions to the duration rule contain many economically relevant scenarios. Our conclusions may be summarized as follows: 1. Independent of the term structure, the CTD has either the highest or lowest coupon of all deliverable bonds. 2. The CTD maturity is the shortest deliverable maturity if the rate is less than 8%. On the other hand, when the market rate is greater than 8%, the CTD maturity is the largest deliverable maturity when the optimal coupon is greater than 8%; if the optimal coupon is less than 8%, the CTD maturity can have an interior optimum. 3. In contradistinction to the prevailing (and published) belief, the CTD is, in many economically relevant cases, not a bond with extremal duration. 4. While conclusion (2) is derived for flat term structures, we prove that it must hold as the only economically plausible limiting case for all term structures.
JEL Classification: G13
Suggested Citation: Suggested Citation