A nonstationary trinomial model for the valuation of options on treasury bond futures contracts

The application of discrete time term structure models to the problem of valuing Treasury bond futures options is illustrated. The various explicit and implicit options and contract details that need to be accounted for are carefully laid out. The test procedure is implemented using the Bliss-Ronn (...

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Bibliographic Details
Published in:The journal of futures markets 1994-08, Vol.14 (5), p.597-617
Main Authors: Ronn, Ehud I., Bliss Jr, Robert R.
Format: Article
Language:English
Subjects:
Arbitrage
Empirical
Futures
Hedging
Options
Options on stocks
Pricing
Studies
Time series
Treasury bills
Treasury bonds
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Summary:The application of discrete time term structure models to the problem of valuing Treasury bond futures options is illustrated. The various explicit and implicit options and contract details that need to be accounted for are carefully laid out. The test procedure is implemented using the Bliss-Ronn (1989) trinomial, time-varying parameter model. The empirical results display statistically significant power in explaining the time series cross-section prices of Treasury Bond futures contracts and options on these futures contracts. Further, the model appears to have some power to detect "arbitrage" opportunities, but only for low transaction-cost agents able to trade at market prices and borrow-lend risklessly; alternatively, one can interpret these results as yielding asset values closer to the arbitrage-free values of these instruments. The model's successful ability to price Treasury Bond futures contracts and their options is indicative of its more general property as a mechanism for generating hedge ratios for arbitrary interest rate-contingent claims.
ISSN:0270-7314
1096-9934
DOI:10.1002/fut.3990140507