Convexity Bias in the Pricing of Eurodollar Swaps

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Operations, Information and Decisions Papers
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Heath-Jarrow-Morton model
HJM model
interest rates
LIBOR
futures prices
arbitrage
pricing
swap
equivalent martingale measures
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Statistical Models
Statistical Theory
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Pozdnyakov, Vladimir
Steele, John M
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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.

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2002-06-01
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Methodology and Computing in Applied Probability
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