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Convexity Bias in the Pricing of Eurodollar Swaps |
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| Authors: | Pozdnyakov V Steele JM |
| Institution: | (1) Department of Statistics, University of Connecticut, 215 Glenbrook Road, Storrs, CT, 06269-4120;(2) Department of Statistics, Wharton School, University of Pennsylvania, Steinberg Hall-Dietrich Hall 3000, University of Pennsylvania, Philadelphia, PA, 19104 |
| Abstract: | The traditional use of LIBOR futures prices to obtain surrogates for the Eurodollar forward rates is proved to yield a systematic bias in the pricing of Eurodollar swaps when one assumes that the yield curve is well described by the Heath-Jarrow-Morton model. The resulting theoretical inequality is consistent with the empirical observations of Burghardt and Hoskins (1995), and it provide a theoretical basis for price anomalies that are suggested by more recent empirical data. |
| Keywords: | Heath-Jarrow-Morton model HJM model interest rates LIBOR futures prices arbitrage pricing swap equivalent martingale measures |
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