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Pascal spreading of short‐term interest rate contracts
Author(s) -
Merrick, John J.
Publication year - 2000
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/1096-9934(200011)20:10<889::aid-fut2>3.0.co;2-w
Subject(s) - futures contract , arbitrage , economics , financial economics , pascal (unit) , hedge fund , order (exchange) , hedge , econometrics , finance , computer science , programming language , ecology , biology
This article examines the spreading and pricing of short‐term interest rate futures contracts and shows how traditional types of calendar spread positions can emerge as explicit arbitrage solutions. A specific set of intuitive spreading structures, Pascal’s spreading triangle, arises when the underlying daily risk factors are identified as the stochastic coefficients of a high‐order polynomial approximation to the yield curve. No empirically estimated hedge ratios are required for these arbitrage strategies. Application of this Pascal spread framework to pricing and trading the London International Financial Futures Exchange (LIFFE) short sterling deposit futures market over the 1989 to 1998 sample period revealed that the LIFFE’s short sterling arbitrage sector’s efficiency improved markedly over time. The improvement over the decade coincided with dramatic declines in futures trading transactions costs. As a byproduct, the framework extracts and measures the quantitative impact of the Y2K millennium‐turn pricing distortion on the December 1999 short sterling futures contract. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:889–910, 2000