Interest Rate Futures

[andrea.odetti-2]

Hi, I would like to ask you something

I have some little problem bootstrapping a term structure using future
rates, so I tried to understand something about them...

I read Hull about 3 months EURIBOR interest rate futures and I read that a
future price of Z does not imply that the forward interest rate for the 3
months following the expiry date is 100-Z because of convexity adjustment.

Is that true? And if it is, how does the class FutureRateHelper handle it?

thanks

andrea

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[Xavier.Abulker]

Hi Andrea,
I can only answer to the first part of the question:
Is that true?
Yes, this is because of the difference in the nature of Futures and FRA
contracts.
Usually one say that it is unappropriate to use future prices directly in
yield curve constructions the future rate must be adjusted such that
future rate = forward rate + convexity adjustement.
In theory it is possible to make an arbitrage in buying a FRA and selling
the same number of future contracts, the model of convexity adjustment
consists of finding the required fixed rate of a fra such that this
arbitrage is not possible.
The problem now is that  to calculate this convexity adjustement you need:
- correlations between all futures contracts
-  Volatility of future conctracts.

Maybe I'm wrong but what I've seen is that market participants are ignoring
it because it's too complex to measure.
(If you have an accurate idea of the correlation between 3m and 12m futures
contracts tell me!)
Of someone else has another point of view I'd be happy to read it.
Bye
Xavier



                                                                                                                         
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                    eforge.net                             Subject:     [Quantlib-users] Interest Rate Futures          
                                                                                                                         
                                                                                                                         
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Hi, I would like to ask you something

I have some little problem bootstrapping a term structure using future
rates, so I tried to understand something about them...

I read Hull about 3 months EURIBOR interest rate futures and I read that a
future price of Z does not imply that the forward interest rate for the 3
months following the expiry date is 100-Z because of convexity adjustment.

Is that true? And if it is, how does the class FutureRateHelper handle it?

thanks

andrea

----------------------------------------------------------------------------------------------------------------------------------------

La presente comunicazione è destinata esclusivamente al soggetto indicato
più sopra quale destinatario o ad eventuali altri soggetti autorizzati a
riceverla. Essa contiene informazioni strettamente confidenziali e
riservate, la cui comunicazione o diffusione a terzi è proibita, salvo che
non sia stata espressamente autorizzata.
Se avete ricevuto questa comunicazione per errore, Vi preghiamo di darne
immediata comunicazione al mittente e di cancellarne ogni evidenza dai
Vostri supporti.
----------------------------------------------------------------------------------------------------------------------------------------




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[Ferdinando M. Ametrano-2]

Hi Andrea

>I read Hull about 3 months EURIBOR interest rate futures and I read that a
>future price of Z does not imply that the forward interest rate for the 3
>months following the expiry date is 100-Z because of convexity adjustment.
>
>Is that true?
Oh yes, it is! Do you really think that J. Hull could be wrong? ;-)

>  And if it is, how does the class FutureRateHelper handle it?
Not yet. In any case the adjustment is very small for the first few
contracts, so that is quite common not to use it if you only include up to
4-5 contracts.

There are different approaches to the evaluation of the convexity
adjustment. I don't have the formulas handy, but there are mainly two
types. One is based on the volatility of the future contract, the other is
based on the yield term structure (evolution) model selected.

I think that FutureRateHelper should take into account the volatility of
the future contract (that is a convexity adjustment of the first type):
anyone willing to work on that?
Can anyone point to the formulas to be implemented?
Different thoughts anyone?


------------
ciao -- Nando

[Ferdinando M. Ametrano-2]

>Maybe I'm wrong but what I've seen is that market participants are ignoring
>it because it's too complex to measure.
I'm pretty sure there are simple approaches, maybe not theoretically
perfect, but sound enough to be used. Or I wouldn't understand how people
are using 40 future contract to bootstrap the USD yield curve (I've seen
that myself)


------------
ciao -- Nando