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               Journal of Financial Abstracts: Series D
                             DERIVATIVES
                         Working Paper Series
                     Vol. 3 No. 14D, June 6, 1996

                              Edited By:

                         Stephen Figlewski
           Professor and Yamaichi Faculty Fellow in Finance
             New York University Stern School of Business

          Comments and suggestions about the JFA are welcome.
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          Published by the FINANCIAL ECONOMICS NETWORK (FEN)
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     |||||||||||||||       TABLE OF CONTENTS      |||||||||||||||
     ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||


     "An Investigation of Cheapest to Deliver on Treasury Bond
      Futures Contracts"

          SIMON BENNINGA           Hebrew University, Israel
          ZVI WIENER               Hebrew University, Israel


     "Pricing American Interest Rate Claims with Humped
      Volatility Models"

          JUAN M. MORALEDA NOVO    Tinbergen Institute
          TON C.F. VORST           Erasmus University Rotterdam


     "The Convexity Spread between Interest Rate Forward and
      Futures Contract"

          JASON WU                 CDC Capital Inc.


     "The Implied Volatility of U.S. Interest Rates: Evidence
      from Callable U.S. Treasuries"

      Note:  This abstract represents a revised version of a paper
      abstracted in JFA:WPS-C, No. 52, December, 1994.

          ROBERT R. BLISS          Federal Reserve Board of
                                   Atlanta
          EHUD I. RONN             University of Texas, Austin


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                              ABSTRACTS

     "An Investigation of Cheapest to Deliver on Treasury Bond
      Futures Contracts"

     BY:  SIMON BENNINGA
            Hebrew University, Israel
          ZVI WIENER
            Hebrew University, Israel

          Date:     May 1996

          Contact:  Zvi Wiener
          E-Mail:   mswiener@pluto.mscc.huji.ac.il
          Postal:   School of Business, Hebrew Univ,
                    Jerusalem 91905, ISRAEL
          Phone:    (972)-2-883049
          Fax:      (972)-2-881341
          Co-Auth:  S. Benninga: mssimon@pluto.mscc.huji.ac.il
          FEN Ref:  JFA:D-WPS96-456

     An extensive cheapest-to-deliver (CTD) literature has become
     mired in the misconception that the CTD is characterizable
     in terms of duration. We show that exceptions to the
     duration rule contain many economically relevant scenarios.
     Our conclusions may be summarized as follows:

     1. Independent of the term structure, the CTD has either the
     highest or lowest coupon of all deliverable bonds.

     2. The CTD maturity is the shortest deliverable maturity if
     the rate is less than 8%. On the other hand, when the market
     rate is greater than 8%, the CTD maturity is the largest
     deliverable maturity when the optimal coupon is greater than
     8%; if the optimal coupon is less than 8%, the CTD
     maturity can have an interior optimum.

     3. In contradistinction to the prevailing (and published)
     belief, the CTD is, in many economically relevant cases, not
     a bond with extremal duration.

     4. While conclusion (2) is derived for flat term structures,
     we prove that it must hold as the only economically
     plausible limiting case for all term structures.

     JEL Classification: G13

     ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

     "Pricing American Interest Rate Claims with Humped
      Volatility Models"

     BY:  JUAN M. MORALEDA NOVO
            Tinbergen Institute
          TON C.F. VORST
            Erasmus University Rotterdam

          Date:     April 15, 1996

          Contact:  Juan M. Moraleda Novo
          E-Mail:   moraleda@tir.few.eur.nl
          Postal:   Tinbergen Institute (H11-10), Erasmus
                    University Rotterdam, Burg. Oudlaan 50, 3062
                    PA Rotterdam, The Netherlands
          Phone:    +31.10.408.14.65
          Fax:      +31.10.452.73.47
          Co-Auth:  T. Vorst: vorst@opres.few.eur.nl
          FEN Ref:  JFA:D-WPS96-457

     Some of the most recent empirical studies on interest rate
     derivatives have found humped shapes in the volatility
     structure of interest rates. Accordingly, Mercurio and
     Moraleda (1996) have modeled interest rate dynamics in a
     way that allows for such a shape in the volatility and is
     analytically very tractable. Unfortunately, their model
     cannot be used for pricing American style claims with a
     recombining lattice. This paper proposes, similarly to
     Mercurio and Moraleda (1996), a humped volatility of interest
     rates model that not only gives explicit formulas for
     European options on discount bonds but also allows for
     pricing American options in a recombining lattice. In fact,
     it can be embedded in either the Hull and White (1993, 1994,
     1995) tree or the Li, Ritchken and Sankarasubramanian (1995)
     lattice. The paper shows, furthermore, that if a
     deterministic volatility model can be embedded in either of
     these algorithms then so does it in the other one. It is
     also proved that it is not possible to find a volatility of
     the class proposed by Mercurio and Moraleda (1996) such that
     American style claims can be priced using a Markovian
     process for the spot rate.

     JEL Classification: G13, E43

     ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

     "The Convexity Spread between Interest Rate Forward and
      Futures Contracts"

     BY:  JASON WU
            CDC Capital Inc.

          Date:     Undated

          Contact:  Jason Wu
          E-Mail:   wu@cdcc.com
          Postal:   CDC Capital Inc., 9 West 57th Street, 36th
                    Floor, New York, NY 10019
          Phone:    (212) 891-6218
          Fax:      (217) 245-6116
          FEN Ref:  JFA:D-WPS96-458

     This paper presents the derivation of the convexity spread
     between the forward contract and the futures contract based
     on the assumption of frictionless markets. For interest rate
     forward and futures contracts, the convexity spread can be
     reduced to a very concise form:

     0.5*Vol(F)*Vol(r)*rho(F,r)*T**2 where Vol(F) is the absolute
     annual volatility of the futures contract, Vol(r) is the
     absolute annual volatility of the zero rate respectively,
     rho is their correlation coefficient, and T is the maturity
     of the forward or the futures contract. The result shows
     that the convexity spread increases dramatically with
     maturity T. Therefore, it is much more important for
     contracts with longer maturities than shorter ones. The
     calculated convexity spread values are consistent with the
     data provided by Dean Witter.

     JEL Classification: G13

     ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

     "The Implied Volatility of U.S. Interest Rates: Evidence
      from Callable U.S. Treasuries"

     BY:  ROBERT R. BLISS
            Federal Reserve Board of Atlanta
          EHUD I. RONN
            University of Texas, Austin

          Paper ID: WP 95-12
          Date:     November 1995

          Contact:  Robert Bliss
          E-Mail:   rbliss@frbatlanta.org
          Postal:   Research Department, Federal Reserve Bank of
                    Atlanta, 104 Marietta St. NW, Atlanta, GA
                    30303-2713
          Phone:    (404) 521-8757
          Fax:      (404) 521-8810
          Co-Auth:  E. Ronn: eronn@mail.utexas.edu
          FEN Ref:  JFA:D-WPS96-459

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          521-8050

     The prices for callable U.S. treasury securities provide the
     sole source of evidence concerning the implied volatility of
     interest rates over the extended 1926-1994 period. This
     paper uses the prices of callable as well as non-callable
     Treasury instruments to estimate implied interest rate
     volatilities for the past sixty years, and, for the more
     recent 1989-1994 period, the cross-sectional term structures
     of implied interest rate volatility. We utilize these
     estimates to perform cross-sectional richness/cheapness
     analysis across callable treasuries. Inter alia, we develop
     the optimal call policy for deferred "Bermuda"-style options
     for which prior notification of intent to call is required
     by introducing the concept of "threshold volatility" to
     measure the point when the time value of the embedded call
     option has been eroded to zero. This concept permits
     appropriate callable-bond valuation. Lastly, we document the
     optimality of the treasury's past call policy for U.S.
     government obligations.

     JEL Classification: G13, H63

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