Risk premia in EuroDollar futures prices Beni Lauterbach & Margaret Monroe Smoller Bar Ilan University, 52100 Ramat-Gan, I...
Definition  <ul><li>Risk premia(Risk premium ) </li></ul><ul><li>The return in excess of the risk-free rate of return that...
Something about Eurodollar futures contract and the market <ul><li>When? </li></ul><ul><li>The market for Eurodollars, whi...
Purpose of this article: <ul><li>Provide additional evidence on the existence and reasons for Eurodollar futures risk prem...
Previous Studies <ul><li>Positive premia in the Eurodollar markets: </li></ul><ul><li>1.Sundaresan(1991) and Meilbroek(199...
<ul><li>Data </li></ul><ul><li>Using Wednesday closing prices of all Eurodollar futures contracts traded on CME from Janua...
A model of Eurodollar futures prices: <ul><li>The settlement price of a contract is defined to be 100.00 minus the officia...
<ul><li>2. The Eurodollar Future price is a function of the expected LIBOR rate at the contract maturity and the total exp...
<ul><li>We can calculate the total expected premium for the (T-t) weeks, from Equation 2.Assuming rational expectation tha...
 
The  mean per-week expected premia  on contract X is estimated as  LIBOR is the 3-month LIBOR rate,  F X ,t  is closing pr...
 
The regression Model
 
 
Summary <ul><li>The fact derived from the article. </li></ul>
<ul><li>Risk premium in euro dollar is independent of the hedging pressures. </li></ul><ul><li>A return of 1% per year of ...
<ul><li>The risk premium is not affected by the interest rate, its volatility </li></ul><ul><li>Hedging has only minor aff...
<ul><li>The spot or the future price cannot explain the positive risk premia in the euro dollar futures market </li></ul><...
Thank you and comments~!
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Risk In Euro Dollar Future Price

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  • Writers incorporate the models of Hirshleifer (1988) and Longstaff and Schwartz (1992) to allow for the effects of factors which affect both spot and futures risk premia, modeling the risk premium as a function of the net hedging pressure, as well as the level and volatility of the underlying spot rate.
  • Risk In Euro Dollar Future Price

    1. 1. Risk premia in EuroDollar futures prices Beni Lauterbach & Margaret Monroe Smoller Bar Ilan University, 52100 Ramat-Gan, Israel and Wayne State University, Detroit, MI 48202, USA Team Member: Yang Liu
    2. 2. Definition <ul><li>Risk premia(Risk premium ) </li></ul><ul><li>The return in excess of the risk-free rate of return that an investment is expected to yield.  </li></ul><ul><li>An asset's risk premium is a form of compensation for investors who tolerate the extra risk - compared to that of a risk-free asset - in a given investment. </li></ul><ul><li>Eurodollars : </li></ul><ul><li>U.S.-dollar denominated deposits at foreign banks or foreign branches of American banks. By locating outside of the United States, eurodollars escape regulation by the Federal Reserve Board. </li></ul>
    3. 3. Something about Eurodollar futures contract and the market <ul><li>When? </li></ul><ul><li>The market for Eurodollars, which are US dollars on deposit outside the United States, has been in existence since the early 1950s. </li></ul><ul><li>One of the most widely traded!! </li></ul><ul><li>Why? </li></ul><ul><li>The increased use of this contract is partly due to its acceptance as the main instrument for hedging short-term interest rate risk by US hedgers (Szymczak, 1988), and non US hedgers (Sherman,1989). </li></ul>
    4. 4. Purpose of this article: <ul><li>Provide additional evidence on the existence and reasons for Eurodollar futures risk premia. </li></ul><ul><li>Writers incorporate the models of Hirshleifer (1988) and Longstaff and Schwartz (1992) to allow for the effects of factors which affect both spot and futures risk premia, modeling the risk premium as a function of the net hedging pressure, as well as the level and volatility of the underlying spot rate. </li></ul>
    5. 5. Previous Studies <ul><li>Positive premia in the Eurodollar markets: </li></ul><ul><li>1.Sundaresan(1991) and Meilbroek(1992) </li></ul><ul><li>the premia in part to the marking to market feature, which causes futures prices to diverge from forward prices. </li></ul><ul><li>2. Bessembinder(1992) </li></ul><ul><li>Eurodollar futures mean returns are positive and larger conditional on short hedging than those conditional on long hedging. </li></ul><ul><li>Further, measures of unconditional betas in this martket to be small : single factor beta is 0.006, which indicates that prices exhibit a risk premium, but with conflicting reasons for its existence. </li></ul>
    6. 6. <ul><li>Data </li></ul><ul><li>Using Wednesday closing prices of all Eurodollar futures contracts traded on CME from January 5 th ,1983 to December 27 th ,1989, and the corresponding weekly LIBOR rates, obtained from the CME annual yearbooks of IMM data. </li></ul><ul><li>Special , the writer omit the 1982: </li></ul><ul><li>To avoid any short-term anomalies caused by traders’ lack of familiarity with the new contract. </li></ul><ul><li>Net hedging data for the period are unavailable. </li></ul>
    7. 7. A model of Eurodollar futures prices: <ul><li>The settlement price of a contract is defined to be 100.00 minus the official 3-month LIBOR on the contract settlement date . </li></ul><ul><li>The present value of the deposit: </li></ul><ul><li>: The present value of the deposit </li></ul><ul><li>: An average of 3-month LIBOR rate </li></ul>
    8. 8. <ul><li>2. The Eurodollar Future price is a function of the expected LIBOR rate at the contract maturity and the total expected risk premium . The futures price at time t is written as </li></ul><ul><li>F T , t+TEP T, t=Et (St)=100-Et (Rt) (1) </li></ul><ul><li>or </li></ul><ul><li>FT, t=100-Et (Rt)-TEP T , t (2) </li></ul><ul><li>St: The present value of the deposit </li></ul><ul><li>FT,t: Current Future price of the Eurodollar. </li></ul><ul><li>TEPT,t: Total Expected risk premium. </li></ul><ul><li>Et(Rt): Expected 3-month LIBOR rate. </li></ul>
    9. 9. <ul><li>We can calculate the total expected premium for the (T-t) weeks, from Equation 2.Assuming rational expectation that the expected LIBOR change Equal to 0, allowing us to use the current LIBOR rate instead of the expected rate. </li></ul><ul><li>=100-Rt-FT,t </li></ul><ul><li>Then we calculate the weekly expected premium as </li></ul><ul><li>EPX,t = </li></ul>
    10. 11. The mean per-week expected premia on contract X is estimated as LIBOR is the 3-month LIBOR rate, F X ,t is closing price of contract X, and TTM X is the number of weeks to maturity of contract X. The per week percentage point expected premium on contract X is computed as
    11. 13. The regression Model
    12. 16. Summary <ul><li>The fact derived from the article. </li></ul>
    13. 17. <ul><li>Risk premium in euro dollar is independent of the hedging pressures. </li></ul><ul><li>A return of 1% per year of the net transaction costs(a small %) </li></ul>
    14. 18. <ul><li>The risk premium is not affected by the interest rate, its volatility </li></ul><ul><li>Hedging has only minor affects on the pricing of euro dollar futures.(Bessembinder,1992) </li></ul>
    15. 19. <ul><li>The spot or the future price cannot explain the positive risk premia in the euro dollar futures market </li></ul><ul><li>The risk premia is not large enough to result in profitable spreads, due to transaction costs . </li></ul>
    16. 20. Thank you and comments~!

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