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The Eurodollar Futures and Options Handbook by Galen Burghardt

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CHAPTER 7The Convexity Bias in Eurodollar Futures

Galen Burghardt and William HoskinsResearch note originally released September 16, 1994

SYNOPSIS

There is a systematic advantage to being short Eurodollar futures relative to deposits, swaps, or FRAs. Because of this advantage, which we characterize as a convexity bias, Eurodollar futures prices should be lower than their so-called fair values. Put differently, the 3-month interest rates implied by Eurodollar futures prices should be higher than the 3-month forward rates to which they are tied.

The bias can be huge. As Exhibit 7.1 shows, the bias is worth little or nothing for futures that have less than 2 years to expiration. For a futures contract with 5 years to expiration, however, the bias ...

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