Last Updated on 10 February, 2024 by Rejaul Karim
The examination expounded in “Term Premium in Interest Rate Futures” navigates the realm of capturing term premium utilizing interest rate futures across a spectrum of eight major currencies, with a pronounced emphasis on the USD.
The study unveils the tendency for the implied future yield from interest rate futures to surpass the realized short-term interest rate, thereby paving the way for capturing this premium through the establishment and rolling of long positions in futures contracts.
Profoundly, this strategic maneuver emerges as a high-performing arsenal, yielding a Sharpe ratio of 0.94 – compared to 0.48 for Treasuries and 0.36 for S&P – over a comprehensive 23-year back-testing period.
Moreover, the observed negative correlation of the term premium return to equity returns underscores its symbiotic suitability within a portfolio predominantly vested in risky assets.
Additionally, the strategy employing rates futures term premium surpasses a long Treasuries strategy both in standalone risk-adjusted terms and as an asset combination with an equity portfolio, encapsulating its formidable prowess within the investment landscape.
Abstract Of Paper
This paper evaluates returns from capturing term premium using interest rate futures across eight major currencies, with a focus on USD. We show that the implied future yield from interest rate futures tends to overestimate the realized short term interest rate and this premium can be captured by establishing and rolling long positions in futures contracts. This strategy delivered a Sharpe ratio of 0.94 versus 0.48 for Treasuries and 0.36 for S&P over the 23 year back testing period for which data is available. The term premium return is negatively correlated to equity returns and therefore fits well into a portfolio that is long risky assets. Additionally, the rates futures term premium strategy outperforms a long Treasuries strategy both on a standalone risk-adjusted basis and as a combination asset with an equity portfolio.
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In conclusion, the exploration of “Term Premium in Interest Rate Futures” unearths the fertile terrain for capturing term premium through interest rate futures, wielding substantial potency across a gamut of eight major currencies, particularly focusing on the USD.
The discerned propensity for the implied future yield to surpass the realized short-term interest rate sets the stage for capitalizing on this premium through the establishment and rolling of long positions in futures contracts.
Notably, this strategic maneuver emerges as a formidable contender, yielding an impressive Sharpe ratio of 0.94 – a marked contrast to 0.48 for Treasuries and 0.36 for S&P – over a comprehensive 23-year back-testing period. The negative correlation of the term premium return to equity returns underscores its complimentary role within portfolios heavily vested in risky assets.
Moreover, the strategy employing rates futures term premium surpasses a long Treasuries strategy both in standalone risk-adjusted terms and as an asset combination with an equity portfolio, underlining its steadfast efficacy and potential as a pivotal investment instrument.
Q1: What is the central theme of the research paper “Trading Ahead of Treasury Auctions”?
A1: The primary focus of the research paper is to develop a model that explains the gradual pre-auction decline in asset prices, particularly observed in anticipation of significant asset sales such as Treasury auctions.
Q2: What factors are considered in the model, and how do they contribute to the gradual decline in asset prices?
A2: The model is rooted in the dynamics of risk-averse investors and their expectations of increased net supply, coupled with imprecise signals. It explores the trade-off investors face between hedging against noise with long positions and engaging in speculative endeavors through short positions. The equilibrium price, influenced by this trade-off, surpasses the anticipated price, leading to a decline in price as noise levels diminish.
Q3: How does the empirical validation of the model unfold in the context of Italian Treasury issuances, and what key insights are derived from this validation?
A3: Empirical validation of the model is conducted in the context of Italian Treasury issuances. The study finds that meetings between the Treasury and primary dealers explain a 2.4 basis points yield increase in the pre-auction period. This underscores the tangible impact of anticipated supply shocks and market-making dynamics in the landscape of Treasury auctions, providing valuable.