The Development and Empirical Tests of an Explanatory Model for Daily Changes in The Treasury Bill Cash-Futures Basis
Lehmann, John Daniel
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https://hdl.handle.net/2142/71510
Description
Title
The Development and Empirical Tests of an Explanatory Model for Daily Changes in The Treasury Bill Cash-Futures Basis
Author(s)
Lehmann, John Daniel
Issue Date
1982
Department of Study
Finance
Discipline
Finance
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Economics, Finance
Abstract
Managing the risk associated with unexpected changes in interest rates is a problem facing borrowers, lenders and fixed income security dealers. Financial instrument futures contracts were created to provide a mechanism to reduce interest rate risk. If the price of the futures contract and the price of the cash instrument being hedged move in perfect lockstep, all risk associated with changing interest rates would be eliminated. These prices, however, do not move in a lockstep manner. The basis, defined as the difference between these prices, does not remain constant and leads to basis risk.
The purpose of this thesis is to investigate the basis movement of Treasury bill futures--specifically to develop a model to explain T-bill basis changes. The empirical results of this investigation led to five conclusions concerning T-bill daily basis changes. First, it was determined that the way the basis was calculated significantly impacted the model's explanatory power. Second, the hypothesized relationships between basis changes and the explanatory variables, when significant, had the expected sign. Specifically, the change in forward rate was always significant and consistently accounted for more basis change variability than the other variables. The change in cost of carry and the T-bill forecast error were significant in only some data sets tested. The high-low futures price spread, a liquidity proxy, was significant in only one of the data sets. Third, qualitative variables used to test for a day-of-the-week phenomenon did not contribute significantly to the model's overall results. It was also determined that the model's parameters change as futures delivery nears. Finally, the hypothesis that the model has not changed during recent periods of relatively volatile interest rates could not be rejected.
Three general implications result from this investigation. These focus on the calculation of the basis, the relative importance of explanatory variables and the changing parameter values as maturity of the futures contract nears.
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