Relationship between Treasury bills and Eurodollars: Theoretical and Empirical Analyses

Relationship between Treasury bills and Eurodollars: Theoretical and Empirical Analyses In this paper, we derive an equilibrium relationship between the yields on Eurodollar and Treasury bills based on equivalent martingale results derived by Harrison and Kreps (1979) and Harrison and Pliska (1981, 1983) as well as the corporate debt pricing model developed by Merton (1974). The derived equilibrium relationship incorporates the models used by Booth and Tse (1995) and Shrestha and Welch (2001) as special cases. The equilibrium relationship indicates that the conditional volatility of the yield on Eurodollars explains the variation in the TED spread. We empirically test the equilibrium relationship using a GARCH-M model and the concept of fractional cointegration. We use both the ex ante data implied by the respective futures contracts as well as the ex post spot data with daily, weekly and monthly frequencies. We find empirical support for the Equilibrium relationship. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Relationship between Treasury bills and Eurodollars: Theoretical and Empirical Analyses

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Publisher
Kluwer Academic Publishers-Plenum Publishers
Copyright
Copyright © 2006 by Springer Science+Business Media, LLC
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-006-0006-7
Publisher site
See Article on Publisher Site

Abstract

In this paper, we derive an equilibrium relationship between the yields on Eurodollar and Treasury bills based on equivalent martingale results derived by Harrison and Kreps (1979) and Harrison and Pliska (1981, 1983) as well as the corporate debt pricing model developed by Merton (1974). The derived equilibrium relationship incorporates the models used by Booth and Tse (1995) and Shrestha and Welch (2001) as special cases. The equilibrium relationship indicates that the conditional volatility of the yield on Eurodollars explains the variation in the TED spread. We empirically test the equilibrium relationship using a GARCH-M model and the concept of fractional cointegration. We use both the ex ante data implied by the respective futures contracts as well as the ex post spot data with daily, weekly and monthly frequencies. We find empirical support for the Equilibrium relationship.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Dec 29, 2006

References

  • Long memory process and fractional integration in econometrics
    Baillie, RT
  • Long memory in interest rate futures markets: a fractional cointegration analysis
    Booth, GG; Tse, Y
  • Residual-based tests for fractional cointegration: a monte carlo study
    Dittmann, I

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